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Merging for survival

Merge or die. That is the essence of survival in today's volatile networking business.

Merge or die. That is the essence of survival in today's volatile networking business.

In the aftermath of the proposed $3.7 billion acquisition of Cascade Communications (CSCC) by Ascend Communications (ASND), it is becoming increasingly clear that such mergers will jeopardize the future of niche players in the networking hardware market.

Like other technology sectors, the networking hardware market is showing signs of maturity, emerging from its proprietary past and embracing common standards. And companies are increasingly articulating a desire to provide customers with everything they need for their network in one-stop shopping. A recent Forrester Research report found that more than 40 percent of the customers they surveyed would prefer to go to one company for their array of routing, switching, and remote access hardware.

The network is the silent facilitator for the Computer Age; in fact, most users don't even think about the network until it goes down. Yet the networking industry remains the fastest-growing segment of the high-technology market, even with recent stock stumbles by major players like Cisco Systems (CSCO) and 3Com (COMS).

Switches and routers send the traffic that each user requests from Web browsers or zips off through email. The hardware combines with the requisite software to provide high levels of performance, management, and flexibility, allowing network administrators to allocate bandwidth and maintain other controls.

The Internet was largely constructed using routing technology from Cisco Systems. The company parlayed that technology into the high-growth area of switches for local area networks through development and acquisition. Noting a fast-growing need for WAN (wide area network) switching gear for high-speed Frame Relay and asynchronous transfer mode pipes, Cisco dropped $4 billion in the spring of last year on StrataCom, immediately becoming a force in an area previously dominated by Cascade and Fore Systems.

Similarly, 3Com shelled out $6.6 billion for U.S. Robotics in late February, signaling that the company did not want to rely on revenue from its current product line alone to spur future growth. 3Com has come under increasing pressure from the companies such as Intel and Bay Networks NetGear subsidiary in the high-volume PC card space, which accounts for about 40 percent of 3Com's revenue. USR offers 3Com a $2 billion modem and enterprise remote access business to add to its routing, switching, and PC card wares.

Others have used partnering to expand their repertoire of products and play catch-up with others technology. IBM (IBM) has seen some of its shops turn to Cisco Systems for networking technology, but recently the company has reemerged as a player to be reckoned through agreements with Xylan and Cascade to resell their products. The Cascade arrangement could either be in jeopardy or could be expanded due to Ascend's move. Xylan may be enticed to formally join the Big Blue fold via acquisition amid this flurry of activity.

The recent check writing could leave specialty players such as Fore, Xylan, and Shiva out in the cold unless they too become victims of these ever-expanding networking behemoths. Bay Networks and Cabletron Systems, in turn, may also come under increasing pricing pressure from these players. And they may also feel the heat to expand their product portfolios.

"Going forward, Shiva will be squeezed out, as it gets harder for smaller players to compete," Thomson Kernaghan & Company analyst Richard Woo said. He predicts that the next step toward consolidation will be between Cabletron and Fore, who currently enjoy a cozy OEM relationship.

"I think [the merger] is motivated by survival," said Dataquest analyst Don Miller. "They need critical mass to compete against these bigger dogs. I think they can and will take market share away from Cisco [in the ISP space]."

The combination of Cascade and remote access giant Ascend will offer certain market segments, such as the booming Internet service provider business, a package that will ostensibly take care of all customer needs. Cascade can provide the switching technology that can connect multiple ISP sites through a managed wide area switch using high-speed technology like Frame Relay. Ascend, in turn, can sell its huge remote access chassis containing modems to those same providers.

"The companies bring very complementary products together, in addition to different product lines. There is no sign of overlap," Woo said.

"After the combined company comes together and gets its channels established, we will see that it leads in terms of technology. It covers IP switching, ATM, and backbone technology," Woo added, which is the kind of diversity that a networking company needs to compete and be successful.

Ascend's stock is taking a nosedive after today's announcement. Cascade recently lost over 30 percent of its stock value in one day. 3Com's stock fell 26 percent one day in early February. In most markets, these signs might indicate a negative trend, but most analysts agree that this will only be a small downward blip on the screen of an industry repositioning itself for future profits.