How to profit from Cisco's purchases
The networking giant's acquisitions tell investors where its leaders see the industry moving, and they're usually right. The latest -- of ArrowPoint Communications -- signals a bull market for intelligent switches.
By Jim Jubak
A lot of investors didn?t need Cisco Systems (CSCO, news, msgs) to tell them that optical networking was the wave of the future. But the company?s $7 billion, August 1999 acquisition of Cerent, a company that had recorded less than $10 million in sales during its existence, certainly sent a message to any latecomers. And it certainly didn?t do any harm to the stock prices of optical-networking competitors to Cerent, such as startup Sycamore Networks (SCMR, news, msgs), which went public in late October at $60 a share and finished the year at $105.
NEW! Market news, updated every 30 minutes by Briefing.com
Cisco took a lot of heat for the price it paid for Cerent. And the criticism still hasn't completely subsided -- it formed a major part of the Barron?s indictment of Cisco as a ?house of cards? in that publication?s May 6 issue. But to me, the Cerent acquisition is already looking pretty smart. When Cisco announced quarterly earnings on May 10, it noted that it expected orders for Cerent?s first product to hit an eye-popping annual rate of $1 billion next quarter.
That?s what happens when a company knows its market inside out.
Cisco's latest acquisition
With those recent numbers in mind, I think it pays investors to take a look at Cisco's most recent multibillion-dollar acquisition. On May 5, Cisco inked a $6 billion deal to acquire ArrowPoint Communications (ARPT, news, msgs), a company that only went public March 31, with about $10 million in revenue in its most recent quarter.
What?s Cisco telling us about the future of the Internet with this buy? And which technologies -- and stocks -- does this deal suggest are worth the most money?
ArrowPoint is a maker of intelligent switches that can direct traffic on the Internet based on information about what content is being requested and how frequently users ask for it. The switches can prioritize traffic so that time-critical data goes over the fastest routes and critically important data gets access to the most reliable routes on a network. Frequently requested data can be cached in servers near the end-user to speed delivery, and different types of requests can be routed to servers specialized to deliver that kind of data. The point is to speed up networks and to make them more reliable and more flexible by making them more intelligent.
ArrowPoint plugs an important hole in Cisco?s product offerings. Cisco?s Local Director software, used to identify and then route content on a network, is an older product that doesn?t stack up well against products from startups such as Alteon WebSystems (ATON, news, msgs), F5 Networks (FFIV, news, msgs), Foundry Networks (FDRY, news, msgs) and ArrowPoint. For the newest tasks at Web-hosting companies, complex electronic commerce sites and application service providers, Local Director simply isn?t fast or smart enough. So buying ArrowPoint will keep Cisco from losing sales to competitors.
But ArrowPoint?s intelligent switches also let Cisco raise the ante in this market. Not only are these switches smart enough to route Web traffic based on the requirements of a specific Web site, but they use a technology called "cookie switching" to direct content based on the identity, authorization and needs of the specific individual requesting data.
You can imagine how attractive this capability is to any e-commerce company. Once the switch identifies the customer, the network can, in effect, be customized for that individual or company based on past patterns of data use. For a new customer, for example, the network could be optimized for routing that user to a database for catalog searches, or to a server that specializes in account setup and credit checks. A Web-hosting company or a service provider could move Internet content that a customer is likely to need closer to that customer before it was even requested, based on past traffic patterns. No wonder that ArrowPoint numbers such prime accounts as Exodus Communications (EXDS, news, msgs) and Road Runner among its more than 200 customers.
It?s likely that after the deal closes, Cisco will push ArrowPoint?s technology into what?s called the enterprise market -- the business of selling routers, switches and other network products to big corporations. These customers, too, are interested in increasing the speed and reliability of their own internal networks, especially as they explore using the Internet to deliver software applications for such key corporate functions as inventory, accounting and customer management.
What the acquisition means
What?s the implication of this deal for investors? (Besides the obvious one -- that Cisco is going to be an even tougher competitor in markets where it is already a top player.)
First, it seems likely that Nortel Networks (NT, news, msgs) and Lucent Technologies (LU, news, msgs), Cisco?s two biggest networking competitors, will move to match the new capabilities that Cisco has acquired in this deal. That could mean a bid for one of the public intelligent-switch companies, such as Extreme Networks (EXTR, news, msgs), Foundry Networks, F5 Networks, or Alteon WebSystems. Only Foundry Networks, with a current market capitalization of $7.7 billion, might be called expensive, given the price tag Cisco put on ArrowPoint. The market capitalization for Extreme Networks is now just $3 billion, and Alteon WebSystems and F5 Networks would sell for even less.
Second, I think Cisco?s investment validates the Web-hosting and application service-provider markets. Market researchers have projected that this market will grow by nearly 50% a year. The price that Cisco paid in this deal indicates to me that Cisco believes in something like that estimate. That?s good news for Web-hosting companies such as Exodus Communications, Global Crossing (GBLX, news, msgs), Qwest Communications International (Q, news, msgs), MCI WorldCom (WCOM, news, msgs), Cable and Wireless (CWP, news, msgs), Metromedia Fiber Network (MFNX, news, msgs) and USinternetworking (USIX, news, msgs).
Third, I think this acquisition clearly raises the bar for what a Web-hosting company or an application service provider has to offer in the way of customization. Commodity hosting is out. It?s not enough to get a customer?s Web site up and to keep it running without major glitches. Now the host has to provide a ?quality experience? for each user of a customer?s Web site. And the Web host has to be able to work with a customer to conserve resources on the customer?s network while optimizing performance.
Fourth, I think this deal also has implications for the communications companies that provide the pipes for the Internet. The price of plain-vanilla communications capacity is headed down, and every telecommunications company on the globe is marketing customized and value-added services. I expect the biggest profits will come from the creation of customized, virtual private networks for individual customers. (A virtual private network juggles connections and capacity on an existing, shared network to give a customer the same experience that a user once got from copper wires dedicated to that specific customer?s use.) Networks that were built out in the last two years or so, or that are now being built out, have much higher semiconductor and software content than older networks. It?s much easier (and faster) to update and reroute a software-rich network than it is to reconfigure one that is literally hard-wired. So it?s much cheaper to create these customized networks for individual customers on software-rich systems. I think this gives a decided edge to ?new network? companies, such as Level 3 Communications (LVLT, news, msgs), Global Crossing, Metromedia Fiber Network and Qwest, over ?legacy network? companies such as AT & T (T, news, msgs) and the former regional Bell companies.
And fifth, I think the trend toward customized networks will speed up the development of other related markets. Hard to imagine, for example, that an intelligent network that recognizes and reacts to an individual user wouldn?t be connected to Web-site content customized for a specific user. Call it a ?virtual private Web site,? since the experience of the common Web site would seem different to each user. Companies in this market that are worth a look include BroadVision (BVSN, news, msgs) and Blaze Software (BLZE, news, msgs). The emphasis on speed and performance that an ArrowPoint brings to the market also should benefit companies such as Mercury Interactive (MERQ, news, msgs) that build products that test the performance of Web sites and report on actual user experience. How else is a customer to know that all those promises are actually being delivered?
Acquisitions offer look inside
I?m not privy to the strategic planning of senior management at Cisco Systems, Intel (INTC, news, msgs), Applied Materials (AMAT, news, msgs) or any other of the big technology gorillas that dominate their markets. But the current trend in the technology world to supplement internal research and development with acquisitions and key venture-capital investments in fledgling companies does give me a way to understand how these companies see their markets developing.
Jubak's Archive
--------------------------------------------------------------------------------
Recent Jubak articles:
? How to run with the Fed and not get trampled , 5/12/00
? How to accentuate the positive in a volatile market, 5/9/00
? A 3-step stopwatch for timing the markets, 5/5/00
More?
Details
--------------------------------------------------------------------------------
Price 54
Change +2 1/8
Research Wizard
Add to my portfolio
Message Board
It?s not a perfect reflection of the thinking that goes on in corporate headquarters. I?ve had to make a lot of guesses and extrapolations in the paragraphs above. But still, these acquisitions represent valuable bits of intelligence. And maybe they're the closest an outside investor can come to actually "being there."
|
