SMARTMONEY.COM: Cisco Throws Its Weight Around
By Alec Appelbaum
Smartmoney.com
NEW YORK (Dow Jones)--In the 1989 Generation-X fable, "Heathers," two stars offer a brief lesson in popularity by conquest. Winona Ryder, playing the chastened Veronica Sawyer, asks Shannen Doherty's scheming Heather Duke, "Why are you such a megabitch?"
"Because I can be," Doherty answers.
In that jaundiced movie, power was the route to high school popularity. In the telecom world, stock can be the currency of popularity. Cisco Systems (CSCO), the pre-eminent maker of equipment that steers data between computers, wants to bump established vendors from phone companies' favor. Cisco has recently made 12 acquisitions and forged two high-profile alliances because it needs to provide those phone companies with compelling products and services. It made those deals in five months because, with its track record and $218 billion market cap, it can.
It's a record of a company dead-set on wresting market share away from its rivals, and using a tireless stock to do it. Cisco's scrapbook from the spring and summer of '99 begins with two companies that work on modernizing phone networks and ends with the two-in-one purchase of Cerent, a maker of high-bandwidth equipment for local-phone traffic that had filed for a public offering, and Monterey, which makes gear that helps guide traffic from old copper networks onto newer, faster, fiber ones. "The whole optical business is the fastest-growing subsegment of telecom today," says Patrick Houghton, a Wall Street Journal All-Star analyst with Sutro & Company, describing Cisco's realpolitik. While Cisco paid around 680 times Cerent's six-month revenue (it trades around 20 times its own annual revenue), Houghton trusts the company's growth will cover its free spending. "If one of these acquisitions is a bust, we'll never know about it."
It's not rare in the rapidly reshuffling game of telecom equipment for companies to buy engineers and figure out how to sell their products later. Having a horse in the race can matter as much as knowing when the race starts, because it gives a company a stable of whizzes ready to whip together whatever customers decide they need. Cerent solves a short-term problem by letting Cisco manage more bandwidth, says Data Communications magazine editor David Newman; it also strengthens Cisco's long-term courtship of phone companies that want to cram many services onto their networks. "Our goal is to delight our customers," Cisco Executive VP Don Listwin said during the company's third-quarter conference call. "We continue to see a growing shift in the way customers view telecommunications." In that shift, the old gear that ran single-line phone connections is being supplanted by new gear that runs digital, multimedia connections from many places across many networks.
Cisco swallows companies like a weight trainer swallows dietary supplements. Having claimed big-dog status in switches and routers used in data networks, it's buying the engineering expertise it expects to need to mount an assault on the business of providing similar gear for phone networks. This looks like a struggle against Nortel Networks (NT) and Lucent Technologies (LU), which have historically supplied the most gear to phone companies. Among Cisco's recent acquisitions, Fibex and Sentient load different kinds of data onto existing networks; Amteva and Calista software make Internet backbones more attractive to business customers; and optical-networking hardware makes it cheaper and easier for local-phone companies to run ultra-fast communications with fewer pieces of equipment. "Lucent and Nortel together control about 50% to 60% of [Cerent's] market," says Houghton. If Cisco funnels Cerent's offerings through its potent sales force, its rivals "will have to get new products out faster and accept slimmer gross margins."
Cisco also sees services as a key tool for pursuing phone companies. Dataquest analyst Tim Smith notes that Cerent's and Monterey's intended customers include insurgent local-phone companies, Internet service providers and long distance legends like AT&T (T) that are getting into phone-over-cable technologies. All these companies need to build their own networks and expand their own revenue, meaning they defer new gear purchases but then make "massive investment," says Smith. Having a team of credible consultants and hand-holders extolling the virtues of Cisco could help prod these potential customers along.
That's also what drove the alliance between Cisco and IBM (IBM) that the companies announced Tuesday. In exchange for Cisco's pledge to buy $2.3 billion of IBM's chips and server hardware, Big Blue has agreed to stop selling its own switches and routers that compete with Cisco's. Moreover, IBM consultants will sing Cisco's praises to clients all over the world. Mike Daniels, a general manager with Big Blue's global-services consulting wing, started the singing in no uncertain terms in a conference call on Tuesday. "Our clients cannot respond to network needs because they can't get skills, can't respond with speed to business opportunities and are having difficulty in managing high performance levels," he said, implying that Cisco goods could cure this malaise. A link with KPMG Consulting that Cisco announced last month generates the same effect in reverse; Cisco's sales agents will secure customers who will then get help from KPMG in setting up Web sites.
Cisco could use some credibility with traditional phone networks; apart from Sprint (FON), which engaged Cisco to help outfit its new high-speed digital network, none of the big carriers has much of a relationship with the company, says Newman. Since several rivals and networking veterans paint an off-the-record picture of Cisco as being overzealous about pushing gear on weary customers, the service alliances could provide what Dataquest's Smith calls a "goodwill-building opportunity."
Don't forget, when phone companies spend on gear for carrying the Internet across their networks, they'll be spending for the next several decades. Cisco has decided it has to be at the core of that spending. Investors, sending its stock price up 15% since April 8, have told Cisco that it can be.
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