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Networking-cable marriage in works?

Rumors swirl around the possibilities of networking companies making deals with General Instrument and Scientific-Atlanta over set-top box technology.

Why would a networking company that counts on huge revenue streams from its sophisticated technology for phone service and the Internet be interested in a box that allows users to order the latest Leonardo DiCaprio movie for $3.95?

This is what many industry observers are pondering amid a swirl of rumors regarding possible business deals, involving the likes of General Instrument and Scientific-Atlanta. Curiously, networking giants Cisco Systems and Lucent Technologies are among the rumored interested parties.

General Instrument has seen its stock rise 16 percent this week on takeover rumors, and was trading at 36.9375 late today. Philips Electronics, another primary suitor named in reports earlier this week, halted trading in its stock this afternoon, with trading volume in GI spiking on anticipation of a deal. Yet Philips instead announced that it would buy back about 8 percent of its stock.

Most believe that a company like Cisco is more willing to invest in a firm that makes digital cable set-top boxes, rather than own the technology. With an investment, a Cisco or a Lucent could wade into a rapidly-evolving and dynamic market, without having to shift gears away from what they do best--provide high-margin, back-end networking equipment for corporations and carriers.

The idea of pairing a high-end networking company with a cable set-top box maker would have seemed a bizarre idea at one time. But the increasing convergence of computers and television on the one hand, and voice, video, and data on the other, makes the combination seem a more natural evolution today.

Yet company such as electronics giant Philips, may be a more likely candidate to purchase a set-top box company, given its wealth of consumer expertise, according to some. The company reportedly said it has not made an offer to buy GI.

A buyout makes more sense for a consumer electronics player, said Jim Parmalee, an analyst with Credit Suisse First Boston. Parmalee believes that cable modems and digital set-top boxes are headed toward a future where consumers will buy them in retail stores, instead of leasing the technology from cable companies.

Driving demand
An underlying reason for interest on the part of networking companies, is to drive interest in sophisticated services that gobble up bandwidth--a cause that would likely result in more back-end equipment purchases by cable operators and service providers. This is the reason that Cisco, for one, has plans in the works to roll out a new consumer-oriented division, largely focused on providing high-speed access tools for users.

"It's a demand-driver," said David Passmore, president of industry consultants NetReference. "If they can open up these fat pipes, it puts incredible pressure on all these service providers to upgrade their equipment. You attack the bottleneck."

A quick look at past events can provide some insight into why an investment may be more likely than an acquisition, in the case of Cisco. The company has held to a formula of buying small firms with specific technology traits. It's largest acquisition--the $4 billion buyout of wide-area switch maker Stratacom--is an exception, but it is interesting to note that its second-largest buy in terms of employees was the recent $116 million deal for Summa Four, which added more than 200 people to Cisco.

Lucent, on the other hand, has been linked with almost every networking-related company under the sun since its regulatory shackles came off this past fall. The mammoth company now can utilize its multi-billion war chest to buy what it needs to be a player in the data market.

Alliances more likely
Analysts are discounting talk of outright buyouts, yet say further alliances between communications companies with the cable equipment providers are a strong possibility.

A buyout of GI, first and foremost, would be expensive. Mike Beardsley, a financial analyst with Pacific Growth Equities, estimates a buyout would cost a suitor between $8.2 billion and $10 billion. Scientific-Atlanta, with a market capitalization of around $1.5 billion, would be easier to swallow, and that has given rise to rumors that the company too may be preparing to merge with Cisco, Motorola, or Lucent, among others.

Scientific Atlanta declined to comment.

Why are these companies attracting such strong interest?

See special report: 
When worlds collide"Both GI and S-A are in enviable positions seat in terms of cable TV supply over at least next two years," Beardsley said, noting that the two companies should account for 85 percent to 90 percent of the market for digital set-top converters, according to research from Pacific Growth Equities. Digital cable set-top boxes, which allow a cable operator to offer more channels than current analog boxes, provide a convenient entry into the home as well as an expanding array of services.

Companies are looking at S-A and GI because "the digital set top is going to offer digital video services as well as integrated cable modem technology for data services and they will also support voice service at some point," according to Beardsley. Perhaps as soon as the year 2000, these devices will serve as the center of home networks that regulate and control various other consumer electronics devices, he said.

"If the set-top box ends up being as strategic as we think it will be, [GI and Scientific-Atlanta] are a great place to buy in," Beardlsey added.

"As both S-A and GI deploy more digital set-tops, each one becomes more attractive as a takeover candidate," said George Hunt, vice president of equity research for the telecom and cable industries at Interstate/Johnson Lane. GI remains a more attractive partner or acquisition target, since GI has more installed digital set-top boxes than Scientific-Atlanta, he said.

"These successful but relatively small companies are going to have to make some kinds of alliance or merger to compete in this brand new world of cable, delivering voice, video and data service [to the home]," said Cynthia Brumfield, a cable industry analyst with Paul Kagan Associates.