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Wednesday April 11, 8:05 pm Eastern Time
TheStandard.com
The Monterey Incident
By Vishesh Kumar
It's been said that most acquisitions don't work. But with more than 70 acquisitions already, Cisco Systems has made gobbling up promising technologies and teams a crucial cornerstone of its strategy. What Cisco couldn't build, it has bought.
That's why Cisco's announcement last week that it would discontinue its Wavelength 15900, a core optical router it picked up through its acquisition of Monterey Networks, came as such a surprise. But the news should have been anything but shocking. Sources say the router was large and cumbersome with low port density, meaning that it didn't provide much speed and bandwidth for the amount of space it occupied.
Cisco's announcement of the $500 million Monterey purchase came on the same day (Aug. 26, 1999) that it bought Cerent for $6.9 billion in Cisco stock, the highest amount ever paid for a privately held company. While the Cerent switch, a metro SONET product, is one of Cisco's most successful offerings, the Monterey acquisition is the highest-profile belly flop in its acquisition strategy so far.
"It was the first to go bust so prominently and obviously in a market Cisco was trying so hard to get into," said Richard Shannon, an analyst at Epoch Partners. "It certainly highlights the risks involved with acquisitions, even though Cisco does it better than anybody else."
Rather than say its router wasn't up to par, Cisco claimed instead that the market wasn't there yet for the product. But analysts point out that other companies have had success in the high-end optical router market, and it was poor design that was responsible for the lack of sales.
"I personally don't believe Cisco's statement that there isn't a market, because companies like Ciena and Tellium have found a lot of success there," said Shannon.
"The product just wasn't making its way to carriers," said Michael Ching, an analyst at Merrill Lynch. "Perhaps if Cisco was in a more robust growth environment, it would have given it longer. But in this environment, you have to cut your losses and move on."
"Ciena is doing just fine there. The simple reality is that they bought a company that built a box that wasn't as good as Ciena's. It just didn't gain the traction," said Steve Kamman, executive director of networking and Internet infrastructure at CIBC World Markets.
In fact, Cisco had shipped the 15900 to just one customer.
Cisco's announcement is significant because in discontinuing the 15900, Cisco jumped out of a market that analysts feel is on its way, but it doesn't mean that Cisco will not go the acquisition route again. In fact, the company might try again in the high-end optical router market. And despite the heat Cisco is feeling over its recent failure, its overall track record is still great.
"This isn't a dishonor. Not all products are going to win," said Kamman. And while Cisco's currency has slipped enormously since its peak, so have the valuations of companies in the optical networking space.
"Its all relative. Cisco's currency is down, but there are so many companies in the space that have gotten funding. There is no way that even 5 or 10 percent will be able to survive. There are so many companies that do the same thing, and if Cisco won't buy them, they are out. It's between a low valuation and no valuation," said Shannon. "Cisco can still call the shots."
Kamman believes it's likely that Cisco will try to buy back into the high-end market. "If they continue to work on this integrated end-to-end strategy, they have no choice but to develop a switch." said Kamman, citing switch makers like publicly traded Sycamore Networks and venture-backed Tellium and Calient Networks as possible targets. "For privately held companies, it depends on whether they can get a higher valuation selling to Cisco or through an IPO."
But private companies have little access to the public markets right now. Tellium, for instance, has been stuck in IPO registration since the markets collapsed. "If we got an offer from Cisco, we would definitely take it to our shareholders," said Charles Corbalis, president and CEO of Calient.
But a new acquisition probably would not happen immediately. For one thing, Cisco is busy sorting out its own affairs and may not be up to absorbing another company.
Cisco is also well off its highs, and analysts say the stock is still expensive and has rough waters ahead. "We believe Cisco has significant downside potential based on valuation. We are significantly lowering estimates based on an increasingly worse outlook," wrote Paul Johnson, an analyst at Robertson Stephens, in a report. Cisco closed Wednesday at $17.40, down 77 percent from its 52-week high of $76.
"Investors and management want to focus on the internal problems. The company is seeing its first quarter of sequential decline, and right now its about the fundamentals," Ching said. "But the Monterey incident isn't going to discourage Cisco from acquiring."
Shannon pointed to another problem. "They could definitely buy into the space again," he said. "But it would look bad right now because they just said there was no market there."
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