Cisco Systems (Nasdaq: CSCO) continues to wow Wall Street as it gobbles up networking startups, integrates them and grows revenue. But with each acquisition Cisco is bringing on board more risk.
No one will want to hear about acquisition risk today because shareholders will be too giddy over Cisco's sales of $4.35 billion and a stock split. But we'll give you the acquisition risk heads up anyway.
Cisco: Best tech company around?
We're not saying Cisco isn't worth the lofty price of admission. And we certainly can't argue with the company's second quarter results -- it's amazing how well Cisco has been able to execute. But CEO John Chambers mentioned something on the conference call worth noting for the future.
"Given the IPO market we've made acquisitions sooner rather than later," said Chambers. "That means we carry expenses before the benefit of revenue."
That statement isn't just Chambers' healthy paranoia at work here. It's a fact.
Cisco, which generates $400 million in cash a month, had to acquire Cerent and Monterey Networks last year even though the companies barely had product or revenue. Cisco, however, had to act fast or those acquisitions would have been ridiculously expensive. With a hot IPO market, Cisco would have had to pay at least double to acquire Cerent or Monterey.
Cisco will continue to gobble up unproven startups -- it has no choice.
Overall, the purchases are a good move, but Cisco now assumes all the risks that the market would have sorted out. While Cisco takes on more acquisitions, it has to fend off upstarts such as Sycamore (Nasdaq: SCMR), Foundry (Nasdaq: FDRY), Juniper Networks (Nasdaq: JNPR) among others.
In the last 12 months, Cisco has acquired 20 companies. In the upcoming 12 months, Cisco will acquire another 20 to 25 companies. Many of those acquisitions will be startups, which could out-innovate Cisco or at least swipe employees. Cisco now faces its toughest challenge attracting and keeping executives and engineers.
The solution -- buy the guys trying to steal your employees. In the second quarter, Cisco completed the acquisitions of Calista, Inc., Internet Engineering Group, LLC, Tasmania Network Systems, Inc., and Worldwide Data Systems, Inc. It also closed the purchases of Cerent Corporation, V-Bits, Inc., and WebLine Communications. That's a lot of juggling.
At some point, Cisco has to botch a few acquisitions -- it's the law of averages. The company has a delicate balancing act with its recent acquisition of Pirelli's optical networking business. With Pirelli, Cisco will play in the dense wave division multiplexing (DWDM) market.
Cisco, however, has some challenges ahead. It has to integrate Pirelli, based in Italy, with its Silicon Valley culture. The deal closes in the third quarter.
Cisco also has to take Pirelli's optical networking gear and integrate it with Monterey and Cerent. Chambers said he was "real pleased" with the integration of Monterey and Cerent, but some analysts noted the sales from that dynamic duo only grew at the industry rate.
The company's optical networking unit booked $100 million in the quarter -- good enough to be lumped into the "other" sales category. Routers and switches each accounted for 39 percent of sales with access equipment making up 12 percent of sales. Other sales, which includes the optical gear, training and services sales, accounted for 10 percent of sales.
Other acquisitions may flop. Of course, you won't hear about them. Cisco buries acquisitions so deep in its system you can't tell what purchases paid off and what ones flopped.
With every acquisition Cisco takes on additional execution risk. So far, Cisco has been flawless and investors are fat and happy.
But watch these acquisitions closely -- one slip and Cisco shares could fall from their lofty perch.
No love for Lucent
While Cisco, Nortel Networks (NYSE: NT) and other networking powers post stellar earnings, Lucent Technologies (NYSE: LU), former Wall Street darling, is on the skids.
On a conference call, Cisco officials said Lucent's fiber-optic gear business appears to be slowing while Nortel is gaining momentum.
That assessment only bolsters Schroder & Co.'s downgrade of Lucent Tuesday. Schroder cut Lucent to "underperform" from "outperform." The brokerage said Lucent was discounting as sales slowed and losing key employees to startups.
Following Lucent's latest quarter, shareholders can't be pleased.