Cisco to Acquire Scientific-Atlanta

It's a done deal. Cisco Systems Inc. (Nasdaq: CSCO) this morning announced an agreement to acquire Scientific-Atlanta Inc. (NYSE: SFA) for $43 per share -- approximately $6.9 billion -- in cash. (See Cisco Buys SFA.)

The deal comes sixteen hours after Light Reading reported that Cisco was close to acquiring the cable and video equipment maker. Sources say Cisco felt urgency to make the deal because of the growing importance of the video market and, specifically, Scientific-Atlanta's potential inroads in both the video set-top box and transport deployments at large RBOCs such as Verizon Communications Inc. (NYSE: VZ). (See Sources: Cisco Eyeing Scientific-Atlanta and Cisco Buys SFA.)

Scientific-Atlanta CEO Jim McDonald pointed out that the company holds net cash of $10 per share, so that Cisco was really paying less for the operations side of the business -- about $5 billion. Cisco is paying about three-times sales for Scientific-Atlanta, which logged trailing twelve months revenue of about $2 billion -- but that includes $1.5 billion in cash held on the company's balance sheet.

The merger creates a formidable competitor in the cable equipment and consumer video market. Scientific-Atlanta is generally considered the No. 2 player in the set-top box market, after Motorola Inc. (NYSE: MOT). It has recently ramped up its development of IP-enabled technology and it also markets video head-end transport gear.

The merger has the potential of tying all of Cisco's video products together into one big network, from optical transport to video transport and cable modem termination systems (CMTSs), all the way to the consumer set-top box.

On this morning's conference call, that was the message that both McDonald and Cisco CEO John Chambers tried to get across. They point out that they can now market an end-to-end, IP-enabled video network that may be sold to both cable companies and telecom service providers.

"An integrated architecture is the only way to reduce this complexity [of convergence]," said Chambers. "The more you provide an end-to-end solution to service providers and consumers, the greater your chance of getting a large portion of capital expenditures."

McDonald said the deal was also about grabbing a piece of the business being generated by the deployment of video services by the large telecom providers.

"As the telephone guys enter the market, we don’t have that long relationship with those guys," he said. "We can get a lot of acceleration because Cisco has those relationships. We have the products, we just don’t thave the relationships with the customers.”

Some analysts agreed, noting Cisco's need to acquire more pieces of the video puzzle.

"You can't do video plays half-heartedly, one little piece at a time," says Scott Clavenna, chief analyst with Heavy Reading. "Though this may seem out of character for Cisco, this is really the only way to quickly get a real end-to-end solution together for video services and in most respects goes well beyond what traditional telco suppliers have done to enter the video game."

In the Q&A session following the conference call, there were several questions about managing the integration of the firms and how the cultures would mesh.

Chambers said that the companies had "similar cultures," joking that he shared a Southern heritage with Atlanta-based Scientfic Atlanta. "I speak with a Southern accent," he drawled.

McDonald, who at 65 is believed to be close to retirement, said he and the top Scientific-Atlanta management will stay at Cisco for at least two years.

Following the close of the transaction, Scientific-Atlanta will become a division of the Routing and Service Provider Technology Group under Cisco senior vice president Mike Volpi. McDonald will report directly to the more youthful Volpi. (See Mike Volpi, Cisco Systems.)

Cisco said it believes the purchase will be "neutral" to earnings in fiscal year 2006 but could add to Cisco's profits in the following year.

Many analysts believe the biggest threat to the deal is that it will lower Cisco's profit margins, since the margins on Scientific-Atlanta's products are significantly lower than those on most of Cisco's products.

This is a concern similiar to that folks had when Cisco bought Linksys. Again, Chambers's answer is that Cisco sees the products as part of the "whole solution" to sell to video customers, in the belief that the facilitation of a more integrated package of IP-enabled video products adds value to the merger.

— R. Scott Raynovich, US Editor, Light Reading