Critics carp at Cisco; Chambers shrugs

Cisco has spent billions buying its way into next-generation networking. But, hey -- it's just "Cisco dollars".

Cisco Systems, the Pac Man of the computer networking business, spent so much money gobbling up its latest targets that some think it should get indigestion.

Cisco spent $6.86bn (£4.25bn) in stock to buy Cerent and another $501m to buy Monterey Networks. Cerent isn't profitable and Monterey doesn't even have a product on the market. "Cerent is a great company, they make a great product. I have a major problem with the return on investment," said Frank Dzubeck, president of Communication Networks Architects, a consultancy in Washington, D.C.

Dzubeck thinks Cerent's technology, which connects fibre-optic networks and other kinds of networks, won't be as important two years down the road. "I don't think the long-term implications can justify spending $7bn." Another analyst, shaking his head over the cost, said the deal was done in "Cisco money".

"These literally are Cisco dollars. You shouldn't look at it as real money," said Craig Mathias, principal at The Farpoint Group. Mathias noted that, even if Cerent was on track to do $100m in sales, that was "barely noticeable" in the $300bn market for telecommunications equipment. "Are customers jumping up and down to buy this stuff? Obviously not. This product may figure quite prominently over time, but it's hard to imagine right now."

Cisco CEO John Chambers begged to differ.

In an address at the DellDirect Conference in Austin, Texas, Chambers said "anyone who understood our market understood that optical transport was going to explode. The key is to watch the market and act". Chamber also said Cerent's rapid growth means that "it would have fetched a much higher number in an IPO".

The deals represent one of Cisco's most aggressive moves yet into the hot market for optical networking, which uses fibre-optic cables to transmit data, voice and video across phone and data networks. They also should, analysts said, turn up the heat on such Cisco competitors as telephone equipment suppliers Lucent Technologies and Nortel Networks. It also lets Internet service providers change the effective size of the data pipe, known as bandwidth, almost on the fly. Service providers such as PSINet, a Cerent customer, could then allocate bandwidth in a matter of minutes rather than the several days now required, Cisco said.

Of course, with a market cap above $220bn, trading out $7bn in stock isn't a huge sacrifice for Cisco, even if it's potentially the biggest-ever acquisition of a privately held company. Cisco Chief Financial Officer Larry Carter told analysts that it would be only "neutral to slightly dilutive" to net income. Cisco will take a charge of 7 cents to 11 cents a share in the current fiscal first quarter for in-process research and development. "Everyone's really focused on the cost of the deal. It's not like they're plunking down cash for this company," said James Slaby, an analyst at Giga Information Group. "What Cisco has done here is come up with table stakes to play in the carrier world. This suddenly makes them if not a heavyweight, certainly a middleweight in next-generation carrier networks."

Analysts agreed that Cisco was spending as much for Cerent's customer list as for its Cerent technology. The buyers of Cerent's 454 have primarily been telecommunications companies, which typically give Cisco short shrift, preferring Lucent, Nortel and other long-established telco providers. While Cerent is losing money -- it lost $29.3m, or 54 cents a share, on sales of $9.92m for the six months that ended 30 June -- its annual sales are now at a run rate of $100m, Cisco executives said on a conference call.

Cerent was founded in 1997 and now has 287 employees. In July, it planned to raise $100m through an initial public offering, but analysts said it was obvious that Cisco had made Cerent an offer it could not refuse. Cisco already owned 8.2 percent of Cerent.

The deal also came together quickly. Mike Volpi, who heads up Cisco's corporate shopping, contacted Cerent CEO Carl Russo, and the two met 11 August, at which time Volpi conveyed Cisco's interest in buying the 2-year-old firm, according to insiders familiar with the deal. Two days later, the two men sat down with Cisco CEO John Chambers, and within two hours, the three struck an informal agreement.

Monterey Networks makes so-called cross-connect technology that boosts network capacity deep at the core of an optical network. It is now testing products with Internet service providers.

Such moves are rapidly expanding the size of the market Cisco is addressing. According to Michael Cristinziano at Gerhard Klauer Mattison & Co. in New York, in 1998 it was addressing a market worth $20bn and had about 50 percent of it. But by 2002, because Cisco is aggressively moving into new markets, Cisco's market opportunity will be $140bn.

Cerent's and Monterey Networks' technology "is something service providers lust after, and to be able to do it over state-of-the-art, high-bandwith optical equipment makes all the sense in the world", Cristinziano said.

PC Week's Carmen Nobel reported from Austin, Texas. Material from Reuters was used in this story.

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