In one $5.3 billion swoop to acquire Scientific-Atlanta, Cisco grabs a whole new video infrastructure market to play in, and with it relief from the confines of its stagnant business-networking rut.
For Scientific-Atlanta, it's obviously a sweet hookup with the world's leading Internet gearmaker, and a big door opener to international sales channels.
While industry observers see the big picture technology fit, the deal didn't receive a great reception on Wall Street Friday. Scientific fans felt shortchanged on the premium and Cisco watchers smelled a slight whiff of desperation in the move.
"Investors are going to question the strategy in the near term," says one hedge fund manager who is long SFA and has no Cisco position.
Cisco shares fell 38 cents to $16.99, and Scientific, after rising 23% over the past month on deal speculation, was up 68 cents to $42.13 at midday.
Some analysts say Cisco got a steal with the deal priced at $43 a share in cash. Fans say Scientific is a profitable venture with a potentially huge growth market ahead as phone companies and cable shops square off over advanced digital service offerings like video-on-demand and high-definition programming.
By Cisco's estimates, Scientific will have a neutral impact on earnings this year and contribute in fiscal 2007, which starts in July.
But analysts like J.P. Morgan Chase's Ehud Gelblum say that contribution could be "north of $1" a share next year.
Scientific is the No. 2 supplier of video networking gear and set-top boxes to cable companies. Rival
, through its acquisition of General Instrument, is No. 1. Both Motorola and Scientific are vying for contracts with phone companies that have plans to offer video-over-the-Net, or IPTV.
In March, Scientific won a $195 million deal to provide video distribution systems for two super hubs that feed 41 regional hubs for
. And in August, SBC awarded Scientific and Motorola a deal for set-top boxes.
Scientific chief Jim McDonald, who has committed to staying with Cisco for two years, says there are more orders in the pipeline, including a big supply deal now in the works.
With all the networking fun to be had in IPTV, Cisco clearly wanted a bigger part of the action, say analysts.
Notably, Cisco lost out earlier this week to
in a $2.5 billion deal to build Australia's
Cisco is "definitely" desperate, says the hedge fund manager. "Losing the Telstra deal was probably seen as a nail in the coffin."
Desperation would obviously explain Cisco's willingness to break its pattern of small acquisitions and reach well outside its core area of tech expertise.
And while Scientific's boxes aren't sold at
or other retail outlets, they are a relatively low-margin consumer electronics device. Scientific's gross margins are between 37% and 40%, which could be seen as a threat that could narrow Cisco's ample 68% margin.
The Scientific deal doesn't come as a complete surprise. Some analysts say Cisco has been heading this direction for a few years now, ever since the acquisition of home wireless router maker Linksys.
Cisco has been doing more and more to get further into the home," says one Wall Street analyst. "This is just another way to diversify its product base and reach into new areas."
But not all of Cisco's new paths have led to success.
Early efforts to convert phone systems like Sprint and countless telco upstarts or CLECs to run on Internet protocol sputtered and in many cases failed. Similarly, Cisco was hired to replace Merrill Lynch's old-line office phone system with Internet protocol gear.
IP is still the future of networks, but getting there directly without major snags has been difficult. That's why investors have more than a few doubts about the already dodgy progress of IPTV and Cisco's complete conversion to the movement.