Wow! Tulip City: Cisco to Acquire Cerent For $6.9 Billion in Stock. Cisco Systems Inc., in what is believed to be the highest price ever paid
for a closely held technology company, has agreed to acquire networking
start-up Cerent Corp. for about $6.9 billion in stock.
The purchase, Cisco's costliest to date, is the latest sign of the Internet's
mind-boggling impact on corporate valuations. Cerent, a Petaluma, Calif.,
company making devices that route telephone calls and Internet traffic on
and off fiber-optic lines, commanded the extraordinary price even though it
has posted only $10 million in sales in 2 1/2 years in business and has
never turned a profit.
"This is unbelievable, and unprecedented,"
said Greg Rossmann, a managing director of
the technology investment banking firm
Broadview International. "It is truly reflective of the expectations for how
the Internet infrastructure is going to be forced to evolve to support the
demands of e-commerce."
Vinod Khosla, Cerent's chairman and a prominent Silicon Valley venture
capitalist, said the deal appears to be the largest ever involving a private
technology concern. And for the investors who had put about $85 million
into the company, it is a huge payday.
Mr. Khosla's venture-capital firm, Kleiner Perkins Caufield & Byers, for
example, invested about $8 million for what is now a 30.8% stake with an
indicated value of $2.1 billion in Cisco shares. Carl Russo, Cerent's chief
executive, owns a 5% stake valued at $342 million. Cisco had already
held about 8.2% of Cerent through a $13 million investment last fall. Other
Cerent investors include computer magnate Michael Dell, who bought $30
million of convertible notes just last month.
Cisco, San Jose, Calif., plans to announce the acquisition Thursday, along
with a deal to buy Monterey Networks Inc., a Richardson, Texas,
networking concern, for about $450 million in stock. Executives from
Cisco and the target companies briefed employees Wednesday.
Quest to Become Leader
Speaking with Cerent employees, John Chambers, Cisco's chief executive,
said his company is determined to be the leader in optical networking
technology. "We don't think this can be done by one company without
combining skills," he said.
Cisco began by making the routing devices that direct traffic on the
Internet. Since then, it has built a broad-line networking business by using
the purchasing power of its lucrative stock, which created a market
capitalization that stands at more than $220 billion. Cisco's shares closed
Wednesday at $68.625, up $2.25, on the Nasdaq Stock Market.
Cerent at a Glance
Figures are for the first six months of 1999:
Headquarters
Petaluma, Calif.
Founded
January 1997
Employees
210
Revenue
$9.9 million
Net loss
$29.3 million
Key investors
Cisco Systems, Kleiner Perkins
Caufield & Byers, Michael Dell
Major customers
Qwest Communications, Frontier,
Williams Communications, PSINet
Business
Produces routers designed to
switch telephone calls and computer
traffic on and off fiber-optic lines.
Source: The company
The latest two purchases are Cisco's 39th and 40th acquisitions. Its deal
for Cerent tops the $4.6 billion it paid for StrataCom Inc. in 1996. But
those companies could hardly be more different.
StrataCom was a profitable, publicly traded company with annual sales of
$330 million and 1,000 employees. Cerent has just 266 employees and
has accumulated $60 million in losses in its brief history. It had filed
recently to go public in an initial offering expected to raise $100 million.
Of course, Cisco is a lot bigger today than at the time of the StrataCom
deal. Its fiscal 1999 sales of $12 billion are roughly three times 1996
levels, and its stock-market value has swelled roughly eightfold.
Moreover, Cerent is widely perceived to have a head start in an exploding
market. Its equipment serves as a bridge between long-haul
communications lines and the local telephone and data network, helping to
reduce congestion and allow phone companies to move more types of
data faster.
Attracting Customers
The company has attracted more than 100 customers since it began
shipping products last fall, including Frontier Corp., Williams
Communications Group Inc. and Qwest Communications International Inc.
Those companies are attracted by Cerent's ability to handle both telephone
calls and computer traffic, while working seamlessly with existing telephone
networks.
Cisco executives explained that the Cerent deal was so expensive because
the impending Cerent IPO required them to peg the valuation to the IPOs
of other young networking companies whose stocks have soared since
going public earlier this year. For example, Juniper Networks Inc.,
Mountain View, Calif., is valued at nearly $11 billion and Redback
Networks Inc., Sunnyvale, Calif., at nearly $6 billion, less than three
months after going public.
"The word was, this was going to be as big as Juniper," said Ammar
Hanafi, Cisco's director of business development.
Shares in these companies have soared, even as other Internet issues have
sagged, because telecommunications firms are expected to spend
hundreds of billions of dollars in coming years to rewire the globe to
accommodate the explosion of computer traffic generated by the Internet.
Cisco hopes the acquisitions of Cerent and Monterey will boost sales to
the telecom companies, the fastest-growing part of Cisco's business. Both
Cerent and Monterey have expertise in routing traffic very rapidly across
fiber-optic lines, which are becoming the primary component of large
communications networks but operate differently than the corporate
networks at which Cisco is expert. Cerent's first product, for example, can
handle 240 gigabits of data a second, the equivalent of 3.8 million phone
calls or 160,000 high-speed T-1 lines.
Initial Surprise
Mr. Chambers said he initially blanched when he heard the deal price but
began to see the logic in the amount. Though Cerent had less than $10
million in revenue in the six months ended June 30, it is increasing product
shipments so quickly that it is now on an annualized run rate exceeding
$100 million, he said. Cisco expects revenue to swell to about $300
million next year, making the purchase price about 23 times sales, a
multiple in keeping with Cisco's financial structure, he said.
Mr. Chambers also compared Cerent with Crescendo Communications
Inc., which had roughly $10 million in annual sales when Cisco acquired it
for $92 million in 1993. Today, Crescendo's products are at the core of a
Cisco unit with annual sales of $4.5 billion.
But Mr. Rossmann of Broadview, which wasn't involved in the transaction,
said the explosion in Cerent's market value could remain controversial.
"This is not a cure for cancer or a warp drive; it is an evolutionary
technology that appears to solve some telephone-carrier problems," he
said. "The real question is how can a Cisco shareholder believe that this
dramatic expenditure of equity is going to yield a return."
Cisco expects to close both acquisitions in its fiscal first quarter, ending in
October. The Cerent deal will be accounted for as a pooling of interests.
The Monterey deal will be accounted for as a purchase. Cisco said it
expects to take a charge of approximately seven cents to 11 cents a share
in the fiscal first quarter for purchased research-and-development costs
connected to the Monterey acquisition. Cisco also had a minority stake in
Monterey.
--Don Clark contributed to this article. |
