By plunking down US$7.4 billion on two start-ups that haven't made any money, Cisco is showing its resolve to become one of the dominant telecom companies in the 21st century.
Cisco this week said it would buy privately held Cerent of Petaluma, California, and Monterey Networks of Richardson, Texas, for $6.9 billion and $500 million in stock, respectively. Cerent develops SONET transport products that combine add/drop multiplexing (ADM), digital cross-connect and time division multiplexing (TDM), as well as packet and cell switching. Monterey builds optical cross-connect technology that is used to increase network capacity at the core of an optical network.
By acquiring these companies, Cisco enters a business sector -- optical transport -- currently dominated by the old-guard telecom equipment suppliers.Optical transport will be a $10 billion market by 2002, Cisco predicts.
More importantly, Cisco now joins the ranks of Lucent, Nortel Networks and Tellabs as a supplier of SONET-based transmission gear for inter- and local exchange carrier networks. But Cisco's newly obtained technology is optimized for transport of multiservice traffic -- voice, data and video -- while the incumbents' equipment is tuned for voice.
The price Cisco is paying for Cerent is a steep one. Cerent lost $29 million in the first six months of 1999 on sales of $10 million. In fact, Cerent has never posted a profit since starting business in 1997.
The acquisition of Cerent is Cisco's largest ever, dwarfing the $4 billion Cisco paid for StrataCom in 1996.
But such is the price to be paid to attempt to lead in the Internet economy. Also, Cerent was about to go public just before the Cisco offer and many, including Cisco, were anticipating the company's value to skyrocket, similar to the stratospheric rise of Juniper Networks. Juniper went public three months ago and is now valued at $11 billion.
Valuations aside, Cisco now has another valuable weapon with which to battle the entrenched telecom giants for the core of service provider networks.
"It's a key piece that's been missing from Cisco. It lets them play directly against the Lucents, the Nortels and the Alcatels for a core optic offering," says Craig Johnson, principal analyst at The PITA Group in Portland, Oregon. "It's key for them to really go into the regional Bell operating companies and say, 'Look, we can provide pretty much anything that Lucent and Nortel can offer.' "Cerent has more than 100 service provider customers nationwide, including current Cisco customers Qwest and Frontier. Monterey has no announced customers.
With these acquisitions, which are expected to close at the end of October, Cisco now has 900 employees focused on optical internetworking.