Editor's Note: Below is an email our Technology Sector Head Ami Joseph sent this morning to Hedgeye CEO Keith McCullough and Senior Macro analyst Darius Dale. For more information on our institutional research email firstname.lastname@example.org.
Hi Keith & Darius,
I wanted to make sure you saw that CSCO reported last night and referenced macro as part of the reason for their guidance miss. The company guided 0-2% y/y growth in F1Q20 versus Street at 2.5% y/y.
For context, three quarters ago they were at ~8% y/y (4-5% organic). The company blamed weaker Service Provider spending (that’s Verizon, T, etc) and within that category mainly blamed China. Management also noted that public sector spending was very strong, and that overall enterprise was good (+ in Europe) but China again the culprit in Enterprise. Cisco had only <3% total revenue exposure to China but said it went 25% lower as Cisco is being “uninvited” to bid for business.
As the call went on, the CEO added more than just China as culprit and basically noted how July didn’t feel like a normal fiscal fourth quarter finish, which usually has a flourish. The CEO immediately checked in with his top clients who said there is no change to how they are using technology in their businesses or roadmaps, but he thinks that maybe there is a macro effect.
Salient quotes below.
CEO & CFO QUOTES from the earnings call:
First is we had continued challenges in service provider, and I'll double click on that in just a moment, as you saw in the order growth that Kelly talked about. And then we did see in July some slight early indications of some macro shifts that we didn't see in the prior quarter. So those are the 2 things that happened.
Let me double click on service provider just a bit. The Americas was generally the same from an order perspective from the prior quarter, so no real shift, positive or negative. Europe was actually positive in the SP space. And Asia, we saw continued weakening in our China service provider business. And we had 2 massive build-outs in India a year ago that just didn't replicate this year with the 2 major players there. That's the net of the service provider situation. It's not more complicated than that.
If you look at our overall business, our orders outside of service provider grew mid-single digits. So we feel good in this environment about the rest of the portfolio and the work that we're doing with those customers.
As it relates to commercial enterprise and public sector, and I'm going to probably give you a little more granularity than normal just so you understand what we believe went on, you can see that the portfolio that is being sold into all 3 of those segments is obviously being well received.
Our public sector business on a global basis was up 13%, so we continue to see success. And as you mentioned, Rod, global commercial was up 7%.
The enterprise business was really -- we saw weakness in China, which was -- contributed to it. We saw some weakness in the U.K. in enterprise. And then candidly, in the U.S., as much as I don't want to use compares for an excuse, we had 2 major software deals a year ago that were tough to compare against.
Let me just comment on the China situation. I mean you're right. It's down below 3%. It's a small part of our business. But obviously, when it falls very dramatically, it can still have some impact because it is greater than 0. But long term, it's not a concern that I worry about much at this point. And so that's really the extent of what we saw there. I mean the China reduction contributed to a point of the issue in all of enterprise for us, so it was that significant. And we definitely saw significant impact on our business in China as it relates to what's going on with trade war right now.
I mean at the end of the day, when we are guiding, it's based on what we're seeing with the orders alone, the pipeline and everything else. And the biggest driver of the guide where it is, is the massive decline we've seen in service provider over the last 2 quarters. So that is the biggest driver. Again, like Chuck said, we feel good about the rest of the portfolio from an orders perspective growing in the mid-single digits. But -- China is part of it, but again, like we said, it's small in comparison. But SP is still a large part of the business, and that's driving this outlook that you're seeing.
The overall Chinese market, as I said earlier, is certainly not a major play for us, but it has just dropped precipitously in light of the trade discussions. So it has a short-term impact. And where we are selling, for years, we've sold infrastructure to the large carriers in China, which has just -- it's been slowly declining, and we saw it even decline more rapidly last quarter. And then what we've seen is in the state on enterprises anymore, we're just being -- we're being uninvited to bid. We're not being allowed to even participate anymore. So those are the enterprises. That's where the large impact was this past quarter. So it was just a much faster decline of what we candidly expected.
So basically, we just felt a slight difference in July, I mean, relative to the close rates and just -- it just wasn't as strong a finish as we would normally expect, particularly in Q4. And I think that's what kind of set off the flags for Kelly and I. I met with 17 customers in the last 5, 6 business days, and nothing's changed about how they're thinking about the role of technology and what we do and how we're playing there. So we're monitoring this. We're watching it. We'll see. Obviously, I think what we've seen in the markets in the last few weeks and what we hear from some of the other players would indicate that others have seen similar things, some a lot worse. And I do feel very good about our position and where we are and the level of criticality that we are playing with our customers now versus 5, 6 years ago. And I think that -- so I feel good about that piece.
But that's really what we felt, and we'll just have to see how it plays out and whether we get any resolution on some of these major geopolitical issues that are sort of lingering out there. I've said for like 18 months that I've been amazed at the resilience of the economy. And hopefully, it can bounce back pretty quick if we get to some -- get more clarity on some of these issues, which I think people are just -- I think they're just hedging their bets relative to some resolution on some of the stuff.
Yes. I think one thing that is, I think, important to look at is when we talk about enterprise spending and when many companies talk about enterprise spending, that would be, in some cases, a combination at a minimum of our enterprise and commercial business. And in some cases, people would just include public sector in there, in that sort of a view. And that -- when you put it all together, it was actually quite healthy. The orders were quite healthy. We just had a little bit in July of a feel that -- we just didn't close as strong as we would like. And so we felt like there was even more that we could have done, and it just didn't feel like a normal Q4 finish. And it felt a little bit like some of the macro issues may be manifesting themselves.
So that's really what we saw there.