Cisco to Broaden Its Scope at a Cost of $7.4 Billion

Cisco Systems made its most aggressive move yet into the world of optical networking with agreements to buy Cerent and Monterey Networks for a total of $7.4 billion in stock.

Petaluma, Calif.-based Cerent Corp. and Monterey Networks Inc. of Richardson, Texas, produce state-of-the-art devices to connect and switch signals traveling through high-capacity fiber-optic networks.

The fiber-optic networking market is expected to boom in coming years as demand increases for higher capacity and speed, growing into an estimated $10-billion market in 2002, according to Cisco.

San Jose-based Cisco hopes Cerent and Monterey Networks will give it products that will hasten the migration of telephone, data and video service providers from traditional circuit-based networks to next-generation optical technologies.

The world’s largest maker of data-networking equipment is positioning itself to face the telecommunications giants that traditionally have dominated the optical equipment market: Lucent Technologies, Alcatel, Nortel Networks and Tellabs.

“I think Cisco had to enter the market,” said Erik Suppiger, an analyst with Hambrecht & Quist. “It was going to cost them a lot, but it is a good thing that they did.”

Martin Pyykkonen, an analyst with CIBC World Markets, said this is exactly what Cisco needs to do to keep its sales, profit and stock price rising.

“This does hit in the heart of what Lucent and Nortel are doing and where much of their growth is coming from,” Pyykkonen said.

Cerent’s only product, the Cerent 54, is a box the size of a microwave oven that sits between fiber-optic lines and either routers or cable systems. Using sophisticated software, it organizes and compresses voice, data and video and vastly increases the capacity of the pipe through which that information is sent.

It also lets Internet service providers change the effective size of the data pipe, known as bandwidth, almost on the fly. Service providers such as PSINet, a Cerent customer, can allocate bandwidth in a matter of minutes rather than the several days previously required.

Under the agreements announced Wednesday, Cisco would exchange 100 million shares of its stock--worth about $6.9 billion--for all of Cerent’s outstanding shares.

Analysts say the deal would mark the most ever paid for a privately held technology company. To put it another way, Cisco would pay $24 million for each of Cerent’s 287 employees.

In July, Cerent announced plans to go public to raise $100 million.

The purchase of privately held Monterey is valued at $501 million, based on the 7.3 million shares Cisco is paying. On Thursday, Cisco shares gained 31 cents to close at $68.94 on Nasdaq.

Cerent would be Cisco’s largest acquisition so far. The networking titan has largely followed a strategy of buying smaller, developing companies. Coming in second is its $4-billion 1996 purchase of San Jose-based StrataCom, a maker of switching devices for wide-area networks.

Many analysts called the price being paid for Cerent eye-popping, given that Cerent, founded in 1997, lost $29.3 million on sales of $10 million during the first half of 1999.

But Suppiger said that in the rarefied field of optical networking, Cerent is still a good buy.

“There just aren’t a lot of market leaders that would be cheaper--$6.9 billion is a lot of money for a company without much revenue,” he said, “but relative to what Cisco is getting out of the deal, I don’t think it’s a bad move.”

Over the last few years, the networking world has witnessed a convergence of data and telecommunications networks.

Cisco realizes that its future lies in establishing its presence in the core of networks that carry voice, video and data. At the same time, the behemoths of telecommunications have acquired data networkers. Those purchases have made Cisco’s acquisitions look puny.

Last year, Nortel purchased Bay Networks for $9.1 billion. Not to be outdone, Lucent bought Ascend Communications, a major Cisco rival, for about $20 billion.

Joel Achramowicz, an analyst with investment bank Preferred Capital Markets, suspects that even with Cerent and Monterey, Cisco will have to absorb more companies to plug holes in its optical product line.

“This is the time for Cisco to make purchases because its stock is so pricey,” he said. “I wouldn’t be surprised to see more purchases. Cisco still has a long way to [go to] catch up with Lucent.”

*

Reuters was used in compiling this report.