The Wall Street Journal -- September 1, 1999
By William M. Bulkeley and Scott Thurm
Staff Reporters of The Wall Street Journal
International Business Machines Corp. agreed to sell its networking technology to market leader Cisco
Systems Inc., effectively ending its role as a maker of computer networking hardware after years of struggling
in the lucrative market.
Cisco will pay IBM about $300 million for its intellectual property, according to people familiar with the deal.
In addition, Cisco agreed to buy $2 billion of parts such as chips from IBM over the next five years. People
familiar with the deal said that figure is more than double the amount IBM previously expected to sell to Cisco,
which is based in San Jose, Calif.
IBM, Armonk, N.Y., has been vastly expanding the amount of high-value parts such as chips and disk drives it
sells to other companies in the computer industry. A spokesman said it has inked deals so far this year covering
the sales of $30 billion in parts over the next seven years.
IBM and Cisco also signed an agreement under which IBM's fast-growing global services organization will sell
and service Cisco's routers and switches.
For IBM, the transaction represents a graceful exit from a core computer business, where it was trumped by
nimbler competitors. IBM, the world's largest computer maker, was once the leading equipment supplier for
computer networks, promoting its own method for machines to talk to one another. Cisco, whose stock
market valuation now about equals IBM's, displaced IBM by building gear that understood not only IBM's
language but also the language of other computer manufacturers and of the Internet.
Cisco challenged IBM directly, creating products that connect IBM computers to the Internet. It even opened
an office near IBM's networking products center in Research Triangle Park, N.C., in 1995, where it hired
IBM veterans to help design these products.
"Cisco has eaten IBM's lunch," said Craig Johnson, an analyst for market researcher Pita Group, Portland,
Ore.
Don Young, an analyst with PaineWebber Inc., said IBM is "putting a pretty good spin on an exit strategy." He
said he doubts that the increased revenue from selling parts will offset the loss of sales of IBM network devices
called routers and switches. But, he added, "IBM is pruning its portfolio of a business that didn't have an
attractive outlook without an ungodly amount of spending."
Investors apparently thought both companies gained by the deal. IBM rose $1.375 to $124.5625 in New
York Stock Exchange composite trading. Cisco rose $1.0625 to $67.8125 in Nasdaq Stock Market trading.
The deal is likely to face antitrust scrutiny because Cisco is by far the dominant maker of networking hardware.
According to market research company Dataquest, in 1998 Cisco had 72% of the worldwide router market
and 38% of the localarea-network market, while IBM was No. 6 in each market with 3% shares.
Executives of IBM and Cisco said in a conference call that the relevant question for antitrust regulators will be
the shape of the future networking market in which data, voice and video will all be handled over single
systems. "The winners in that market haven't been established," said Selby Wellman, a Cisco senior vice
president.
Cisco said that by buying the intellectual property related to IBM's products, it will be able to design systems
to easily "migrate" IBM's networking customers to Cisco equipment. Cisco said IBM will help it convert
30,000 customers to Internet-based systems. Cisco executives said they expected as much as $7 billion in
additional revenue over the next three years as a result.
IBM isn't actually selling its networking business to Cisco. However, it said that it won't upgrade the routers
and switches that it now makes. IBM will continue to make other types of proprietary networking products for
customers that already use its technologies known as token ring and Systems Network Architecture. IBM
officials declined to disclose the company's networking revenue.
For Cisco, the deal eliminates a competing maker of networking hardware, and is an attempt to harness IBM's
130,000-person services group as an additional sales force. Cisco doesn't have a large internal services
department and relies on outside consultants such as Andersen Consulting to help customers design, install and
maintain networks. Cisco last month purchased a 19.9% stake in the consulting arm of Big Five accounting firm
KPMG LLC to augment its consulting force.
IBM's services division traditionally has pushed IBM's own networking gear, as well as equipment from other
suppliers such as 3Com Corp. By allying with IBM, Cisco is hoping for a bigger share of that business.
One big loser in the deal is MMC Networks Inc., Sunnyvale, Calif., which supplied chips to IBM for its
networking gear. MMC shares fell 38%, or $19.125, to $30.875 in Nasdaq Stock Market trading before
trading was halted in midafternoon. IBM accounted for 23% of MMC's revenue in its most recent quarter.
MMC Chief Executive Officer Doug Spreng said he expects all of that revenue to vanish by the first quarter of
next year. But Mr. Spreng said MMC has more than $60 million in cash and will be profitable without the IBM
business. Mr. Spreng said MMC doesn't expect to lose business at Cisco, its biggest customer, to IBM.
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IBM's Technology Diaspora Seeking to broaden the market for its technology beyond its own products, IBM
has inked a rash of supply contracts with other tech companies.
COMPANY: DellDATE: March 4VALUE: $16 billion over seven yearsBUSINESS: IBM to provide Dell
with storage, chips and networking and display
technologies.
COMPANY: EMCDATE: March 24VALUE: $3 billion over five yearsBUSINESS: IBM keeps selling EMC
disk drives for its storage systems, while
allowing for broad cross-licensing.
COMPANY: NintendoDATE: May 12VALUE: $1 billion over multiple yearsBUSINESS: IBM to provide
Nintendo with 400 MHz processors, dubbed "Gekko," for a
video-game console.
COMPANY: AcerDATE: June 7VALUE: $8 billion over seven yearsBUSINESS: IBM to sell Acer hard
disks, chips and networking and display
technologies.
COMPANY: Cisco SystemsDATE: Aug. 31VALUE: $2 billion over five yearsBUSINESS: Cisco will buy
IBM-produced equipment; companies will join forces on
networking technology and services.
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