Must read street.com article. Internet Telephony: Lucent and Cisco to Duke It Out for Dominance
[ASND references. In addition, LU buyout of ASND/BAY]
By Kevin Petrie
Staff Reporter
4/29/98 2:31 PM ET
thestreet.com
Editor's note: This is the second in a four-part series
outlining the brewing business of Internet telephony. Part
one, published Tuesday, provided an overview of the
industry and its players. In part three, on Thursday, we'll
look at the companies that build the "gateways" to the
Internet. And we'll wrap up Friday with part four, which
examines prospects for the companies that make
gateway components. If you have comments on this
series, please send them to letters@thestreet.com.
Cisco (CSCO:Nasdaq) and Lucent (LU:NYSE) are
fortifying themselves for a massive battle, even though the
prize they seek is developing slowly and remains
ill-defined.
At stake is not only a new market -- running voice and
faxes over the Internet -- but also their own steep growth
rates and rich share prices.
If the much-hyped Internet telephony business fails to
grow as fast as expected, Cisco and Lucent could find
that they've targeted the wrong market, taking resources
away from other areas. To be sure, both companies have
strong core businesses and won't crumble if Internet
telephony fails to live up to its promise. But it could make
a difference between scorching growth and slow growth,
and could cause these companies' sky-high valuations to
tumble somewhat.
And the battle will include more than Cisco and Lucent.
Other networkers, including Bay Networks (BAY:NYSE),
3Com (COMS:Nasdaq) and Ascend (ASND:Nasdaq), are
rushing toward the market. On the phone-company supply
side, Northern Telecom (NT:NYSE) stands ready to
work its way into the game.
But Cisco and Lucent will climb into the ring in the main
event. Cisco is tuning its computer networking products to
carry voice signals, both for carriers and corporate
customers. Lucent has rolled out an Internet telephone
"gateway" for corporations along with software features;
its recent purchases of data companies will yield similar
hybrid products as Cisco's.
Cisco has built the joints of the Internet. But despite data
networking's overall robust growth, the market still is
relatively small compared with the market for voice
transmission equipment. Just compare the revenue of the
leaders in each space -- Cisco has annual sales of about
$7 billion, and Lucent about $28 billion. So Cisco has
assembled most of the necessary pieces for Internet
telephony as a method of tackling Lucent's huge market.
The pressure on Cisco is high. Its CEO, John Chambers,
might boast about long-run 30% to 50% growth in the data
industry, but lately rivals have groused that it's much less
for them. Investors have fixed too high a price on Cisco's
stock -- 57 times trailing profits -- to tolerate any deviation
from its prophesied growth track, so Cisco is wagering on
a lateral expansion.
"Cisco's making a leap of faith that they can get into the
carrier business," says analyst Jon Sederquist at
Phoenix Investments, a Cisco shareholder. Cisco likely
will succeed, he says, but the cost presents a risk. Cisco
intends to increase R&D and sales expenses past the
30% piece of revenue it made up last quarter, which
equals more than $600 million. Sederquist estimates
Cisco will direct most of that money to carriers and
Internet service providers, which includes both data and
telephony.
Neither company will disclose how much it is wagering on
Internet telephony, but clearly it's not small. Don Listwin,
a Cisco senior vice president, predicts hybrid voice-data
products will generate roughly 10% of revenue -- $500
million or so -- by the end of fiscal 1999, up from virtually
zero now.
In perhaps the strongest indicator of Cisco's belief in the
market, the company has departed from its habit of
waiting for customers to cast their votes on a rising
technology before bulldozing into the market. This
iteration of Internet telephony only surfaced in the last
year or two (other types were kicked around in the '80s).
"It seems that they're hoping to be more of a
standards-setter," says analyst Pete Deininger at
shareholder Firstar Investments. Deininger counts
himself a skeptic on Internet telephony, but says Cisco's
aggressive plans will strengthen its overall business with
phone carriers.
Right now, growth is slow. "The herd hasn't started to
move yet," says Listwin.
Lucent already serves the larger but slower-growing phone
industry, which places a premium on reliability. And its
sheer size and history with the Bells -- it was spun off
from AT&T (T:NYSE) in 1996 -- present an advantage in
this new market. Customers already are asking about its
Internet telephony products "because of our voice
expertise," notes Kathleen Meier, the company's Internet
communications general manager.
With shares trading at 228 times trailing earnings, Lucent
has a more extreme motive to expand than Cisco: namely
that its base phone-gear business promises to flatten
down the road, according to Sederquist at Phoenix
Investments, because carriers slowly will divert
investments to the Internet.
As part of a broader expansion from the phone business,
Lucent is buying data products. The latest deal is its $1
billion acquisition of Yurie Systems (YURI:Nasdaq)
announced Monday. With Yurie and other recent
acquisitions like Livingston and Prominet, Lucent is
hoping to build a full, integrated product line that can
compete with Cisco in shuttling data. Some observers
expect an even larger acquisition later this year; Ascend
and Bay boast product suites that make them potential
candidates.
Cisco, meanwhile, may need a partner, too. It would love
to team with Lucent, because it recognizes Lucent as a
considerable adversary. However, Listwin finds Northern
Telecom a more likely candidate. One sign of friendship is
that Nortel recently exited its investment in a startup so
Cisco could buy it. [Note: This must be Aptis]
Listwin says Cisco also needs the help of current partners
EDS (EDS:NYSE) and Hewlett-Packard (HWP:NYSE) to
integrate the parts into reliable systems for corporations.
H-P can help with phone carriers in particular.
All the saber-rattling aside, one longtime Cisco holder
serenely anticipates this ending up just another chapter in
the company's story.
"Wherever the Internet takes them, that's where Cisco will
go," says Bob Bender, president of Robert Bender &
Associates, which has grown its Cisco stake consistently
since purchasing its first shares for a split-adjusted 53
cents each in October 1990 -- eight months after the IPO.
Bender has never worried about a product transition.
Cisco, he says, will thrive even if Internet telephony flops.
See Also
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4/28/98 1 PM
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Cisco
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