Cisco Needs a New Shopping Spree - TheStreet

Cisco Needs a New Shopping Spree

The company's long-term growth -- and stock price -- are on hold until CEO John Chambers is ready to call a price bottom in potential buyout targets.
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With more than $10 billion in annual free cash flow,

Cisco

(CSCO) - Get Report

may soon be shopping for new acquisitions as it hopes to maintain its long-term growth target of 12% to 17%.

But analysts say CEO John Chambers won't pull the M&A trigger until he sees the absolute bottom of the economic downturn.

"Chambers is looking for bargains, I'm sure, but it's not the main driver. He likes to consolidate during downturns and come out stronger," says American Technology Research analyst Mark McKechnie. "Cisco has built itself around its acquisitions. People will be thinking about what Chambers will do a lot more now that the fiscal fourth quarter is over."

By acquiring 50 companies in the past five years alone, the networking gear giant has developed a reputation of being an aggressive buyer that uses purchases to expand into new areas and key side markets. It's no coincidence that over those same five years, revenue has jumped nearly 80% as Cisco's share price has added about 25%.

However, with a lack of big purchases in the last year, Cisco shares have fallen more than 20%.

"Regarding our cash on hand, I can tell you that Cisco's business strategy is to make investments for growth," Cisco spokesperson Heather Dickinson told

TheStreet.com

. "

Cisco believes that its use of cash provides the company with the flexibility to make strategic investments in the business, including R&D, acquisitions and share buyback."

Cisco's cash may already be burning a hole in its pocket. On the company's last quarterly conference call, Cisco executives said that going forward they will likely acquire small- to medium-sized businesses rather than large ones. "If you think about what we're going to do, we usually acquire ... when we move into new markets that we do not have the expertise for the product segments in," said CEO John Chambers.

Chambers was quick to shoot down rumors that Cisco was in talks to acquire data-storage giant

EMC

(EMC)

, adding that Cisco is more likely to partner with big companies such as

IBM

(IBM) - Get Report

,

Microsoft

(MSFT) - Get Report

,

Intel

(INTC) - Get Report

, and

Accenture

(ACN) - Get Report

.

He did, however, suggest that Cisco would likely approach purchases closer in size and price to Scientific-Atlanta, which the company unexpectedly bought in 2005 for $6.9 billion, and WebEx, which Cisco acquired in March 2007 for $3.2 billion.

Of course, the networking giant hasn't shelled out more than a billion dollars for an acquisition since the purchase of WebEx, and analysts say that the lack of large acquisitions has been a factor in Cisco's slower growth.

"Cisco spent only $400 million on acquisitions this past year, compared to more than $9 billion over the last two fiscal years," says Dave Novosel, analyst with corporate bond research firm Gimme Credit. "A key factor in the slowing growth is the absence of large acquisitions. We expect the company to pick up the pace in fiscal 2009."

Who Cisco buys may not be as important as when it starts buying, many argue. In his run as chief of Cisco, Chambers' comments and actions have always been closely watched as a barometer of the performance of the tech sector. When and if Cisco starts scooping up other companies, it may be a sign Chambers believes the economic downturn has hit a bottom and that the market will start improving.

"Chambers must think a turnaround is at hand if he starts buying companies," McKechnie says. "He's good about making acquisitions during a downturn. If he makes one, you have to think about what signal it sends. Maybe part of why he hasn't bought companies to date is because he hasn't seen the turnaround start to materialize."

If the company does start hunting for acquisitions, a frequently cited target is

Brocade Communications

(BRCD)

. Analysts say Cisco may buy Brocade in order to road-block the $3 billion merger between Brocade and network equipment maker

Foundry Networks

(FDRY)

.

A Brocade deal makes some sense, as it would let the company expand further into storage area network equipment and data-center networking services in order to compete better with

Juniper Networks

(JNPR) - Get Report

. Plus, with a market cap of $2.7 billion, Brocade resembles WebEx in terms of size.

"The Brocade rumor sounds like it came and went, but that doesn't mean it won't find its way onto the list again," says McKechnie. "Chambers has made a lot of noise about storage networking, which is why the Street is hovering around Brocade."

But given that the EMC rumors never yielded any results, analysts aren't buying into the Brocade rumors yet. "If I hear about the acquisition, that's reason enough not to believe it," says Simon Leopold, an analyst with Morgan Keegan. "Their M&A guys are so good at their job. They're not very dependent on investment bankers to come and counsel them and tell them what they need to buy. If we on the Street know about it, it probably simply is not true."

Leopold says that Cisco has several avenues for growth and strategy, but that it would make most sense to expand further into IT services much in the way

Hewlett-Packard

(HPQ) - Get Report

did by acquiring

Electronic Data Systems

(EDS)

and the way

IBM

(IBM) - Get Report

has.

"When you compare Cisco to the other large diversified vendors, one of the key differences is really the amount of the services and solution business," he says. "They're not as sexy, and there's not a lot of gross margin, but it's a good way to expand a portfolio for customers. Services were the savior of IBM."

Looking at services companies that could be possible Cisco targets, Accenture has already been ruled out by Chambers when he said Cisco was more likely to partner with the company. With a market cap of nearly $24 billion, it's a safe bet to say that Chambers isn't bluffing.

Without Accenture or EDS on the table, Cisco could look to several other IT services names as a possible takeover target.

Computer Sciences

(CSC)

,

Ingram Micro

(IM)

and

Tech Data

(TECD) - Get Report

aren't as involved in the enterprise space as EDS and Accenture are, but all three are possible targets for Cisco if it were to move further into IT services.

"It's a unique view to think about Cisco doing services. It seems like a lot of the big mature companies, like HP, IBM and

Ericsson

(ERIC) - Get Report

are moving into services, so Chambers has got to be thinking about it," says AmTech's McKechnie. "Based on his saying he'd rather partner with a bigger guy, buying a smaller name would kill his ability to partner. However, I wouldn't throw anything out."