Cisco goes for video

Cisco is paying cash for the deal, and because it's assuming $1.6 billion of Scientific-Atlanta's cash, the deal is worth about $5.3 billion.

This acquisition marks a major strategy shift for Cisco, which has increasingly expanded its business into the home. Cisco already has a strong position with cable operators, to whom it sells routing and switching equipment. Now the company will own a critical piece of equipment that goes directly into people's homes.

The Scientific-Atlanta acquisition also firmly plants Cisco in the video market. With this gear, it will provide cable operators and the phone companies that also are entering the paid TV market an end-to-end solution for delivering video service. This solution will include everything from the infrastructure equipment that carries the video traffic within the cable or phone companies' own networks to the set-top boxes that are connected directly to TV sets.

Scientific-Atlanta is one of the largest makers of set-top boxes. Along with competitor Motorola, it dominates the market for these devices, which are increasingly becoming more sophisticated. Cable operators and phone companies see these devices as the cornerstone of their strategies to deliver new services, such as digital high-definition television, movies and TV shows on demand, and digital video recording.

Although Cisco has not traditionally played in the home market, the company has steadily been moving in this direction. In 2003 it bought home networking company Linksys for $500 million.

Up to this point, most of Linksys' sales have centered around wireless routers used to connect PCs and laptops in the home. But Cisco has also been moving toward the entertainment device market. Earlier this year, it bought a small European company called Kiss Technology, which makes DVD players that can be connected to other devices in the home.

Cisco sees video as a must-have technology for its future, as its service-provider customers start offering a quadruple play that includes high-speed data, telephony, wireless and television service. Over the past few years, cable operators and phone companies have become fierce rivals as they encroach on each other's businesses.

Phone companies such as Verizon Communications and SBC Communications are building out their networks to deliver paid TV service. And cable operators are now offering telephone service. Some, including Comcast and Cox Communications, have struck a deal with Sprint Nextel to also offer cellular phone service.

"Video is emerging as a key element in the quadruple play," Cisco CEO John Chambers said during a conference call on Friday. "In fact, video may be the most critical element in terms of stickiness for customers ... Video is an integral part of our strategy and must be part of our competency ... It's too important to us to leave to a partnership."

Video is so important to Cisco, Chambers said, it will become the eighth Advanced Technology in Cisco's suite of products. Cisco views Advanced Technology markets, at least potentially, as billion-dollar-a-year businesses for the company. The other advanced technologies are the digital home, optical networking, security, storage area networking, wireless, hosted small business, and IP telephony.

Chambers also said he believes the acquisition of Scientific-Atlanta could be one of the most important the company has ever made. Since the company's inception, Cisco has acquired more than 100 companies. Scientific-Atlanta marks Cisco's 105th acquisition, and the 18th for 2005. Chambers ranks this buy with its acquisition of Crescendo Communications in 1993, which spawned Cisco's successful Ethernet switch business, and Linksys, which launched Cisco into the home networking business.

"And now Scientific-Atlanta will lead us into video," he said. "So I put this in the top four acquisitions we've ever made, if we execute well."

He said that the company plans to take the Scientific-Atlanta products and integrate them with Cisco's routers and switches and home networking equipment to create an end-to-end business. This strategy has worked well for Cisco in the enterprise market, where it provides everything from the core routing infrastructure that connects businesses to the Internet to the wireless gear that allows workers to be more mobile within the corporate campus.

The deal seems equally promising for Scientific-Atlanta, which has been pigeonholed in the cable market. During the call, Jim McDonald, Scientific-Atlanta's CEO, admitted that the company has not been effective in winning deals with the telephone companies that are building new networks to deliver television. The company has also not penetrated the international market, where there is also a lot of activity on the Internet protocol TV front.

"We've lost deals because we didn't have the ongoing relationships with the phone guys," he said. "We have the stuff to sell them, but we don't have the relationships. And Cisco already has those relationships."

The acquisition is expected to close by the end of Cisco's fiscal quarter in April 2006. Scientific-Atlanta will become a division of the Routing and Service Provider Technology Group under the leadership of Mike Volpi, senior vice president at Cisco. McDonald said during the call that he will stay with Cisco for at least the next two years.