Digital Lops Off Unprofitable Parts in Makeover Bid
Jim LeFevre
December 17, 1997
Over the past year or so Digital Equipment Corp. has been lopping off unprofitable business units and selling them to the highest bidder. Now, the company's networking unit is the next subject on the chopping block, and Cabletron Systems Inc. (Rochester, N.H.) is its proud new owner.
Late last month, Digital and Cabletron inked a partnership agreement that not only hands Cabletron the keys to Digital's networking business unit, but establishes reseller and services contracts between the two companies as well. The networking company, renamed the Digital Network Products Group: A Cabletron Systems Company, cost Cabletron approximately $430 million in cash, stock and product credits, and will be operated as a separate division within Cabletron.
According to Don Reed, Cabletron CEO, his company is using the deal with Digital as a springboard to a new corporate strategy that focuses on expansion via acquisition and strategic partnerships. "This agreement will bolster our core business, while linking us with a strong partner for distributing Cabletron products to the enterprise and service-provider markets," explains Reed.
The deal came amid a flurry of industry rumors, which began to appear in the press with increasing frequency after a November 13 article in the Wall Street Journal reported that Digital was on the verge of an agreement to sell its network equipment business to Cabletron. Neither company was willing to confirm that an agreement was in the works, although Digital had reportedly spent the past year looking for a buyer.
The rumor of the networking business's imminent sale was strengthened by the company's chairman and CEO, Robert Palmer, during a press conference following Digital's annual shareholders meeting on the same day the Wall Street Journal article was published. During his address, Palmer conceded that Digital needed to find a partner to bolster its networking product lines and deliver a wide range of products.
The networking deal continues a trend started by Digital last summer, when it sold its printer business to Genicom Corp. (Chantilly, Va.). A highly publicized deal followed this October, when Digital sold its semiconductor manufacturing operations to Intel Corp. for a cool $700 million. Digital also signed a 10-year patent licensing agreement with the semiconductor giant that stands to bring in even more money for the struggling Digital.
Digital's 1,200-person networking unit garnered $100 million in profits in fiscal 1996, but the following year was not so kind: Digital lost money on the division during fiscal 1997, as increasing competition took its toll. This, coupled with the fact that Digital's networking division is responsible for only a small percentage of the company's overall revenue, could have influenced Digital's decision to jettison its networking business.
The sale of Digital's networking unit has added considerable strength to Digital's cash reserves, which currently weigh in at $2.4 billion. In addition, Digital can now focus on the business units that deliver more than 50 percent of its annual revenue: the service and support divisions.
Cabletron has plenty to gain as well with the closing of the deal; its $1.5 billion in annual revenue will be bolstered by some $400 million in revenues. The deal will also fill in several holes in Cabletron's product lineup, particularly in the carrier-class hardware department. Cabletron obtains Digital's new GigaSwitch product line, which is targeted at enterprise-class networks, helping the company compete with industry giants such as Cisco Systems Inc. in this market space.
"Selling this business has been an on-again, off-again thing with Palmer," says Sam Alunni, industry analyst with Sterling Research (Sterling, Mass.), who is somewhat perplexed at Cabletron's presence in the Digital deal. "I really can't see where Digital adds any technical value to the Cabletron product lines, except for the GigaSwitch, and Cabletron has direct sales into the same market segment that Digital does," explains Alunni.
Steve Foote, vice president of research strategies with the Hurwitz Group (Framingham, Mass.), disagrees, claiming that Cabletron is looking to increase its market share, not its technical expertise: "It's not a technology issue; it's a market-size issue. Cabletron's got to go through some growth. Like any acquisition, it's a giant step forward. By acquiring Digital's networking unit, Cabletron will add market share as well as the capacity to produce more product."
Foote goes on to postulate an intriguing possibility: After shedding its networking unit, Digital could become a prime target for a Microsoft Corp. acquisition. "After moving their chip business to Intel, and if the Cabletron deal becomes reality, what do you have left? Some decent engineers, a worldwide distribution organization and a direct sales force. If you're Microsoft, moving into the enterprise space requires a direct sales force. There certainly could be a great relationship between the two companies," concludes Foote. |
