Cisco Systems Inc. (Nasdaq: CSCO) plans to exchange roughly $13.5 million of common stock for SignalWorks Inc., a small, privately held maker of embedded voice processing software, in a move observers say is well timed (see Cisco to Acquire SignalWorks).

You won't find much about SignalWorks on the Web. The company makes acoustic echo cancellation software that corrects that tinny sound in telephone handsets, including ones built for IP-based voice services. A tiny engineering enterprise, it has just nine employees, of which seven will be taken aboard Cisco. CEO Hugh McLaughlin will report to Cisco's Richart Platt, VP of engineering in Cisco's Enterprise Voice and Video Business Unit.

The deal is a small part of Cisco's grander push into voice-over-IP (VOIP) technology.

"Our latest checks suggest Cisco continues to gain momentum with its VOIP offerings, and VOIP remains one of the most important emerging areas for Cisco, along with storage and security," writes analyst Tim Luke of Lehman Brothers in a note today. "We expect Cisco to continue to make investments and acquisitions in this promising arena."

Up to now, SignalWorks has sold its software to OEMs like Hitachi Ltd. (NYSE: HIT; Paris: PHA) and LSI Logic Corp. (NYSE: LSI), which put it in digital signal processor (DSP) modules for sale to other developers or for use in telephones, PBXs, and the like. Cisco will continue to honor such prestanding contracts, says spokesman Jim Brady. But whether Cisco will choose to support OEMs in the future isn't clear.

Indeed, Cisco is intent on dominating the IP telephony market, not helping others join it. Jeremy Duke, principal analyst at Synergy Research Group Inc., says Cisco owned 41.4 percent of the worldwide $863.8 million market in IP telephony gear, including handsets and PBXs, for 2002. That puts Cisco well ahead of competitors Avaya Inc. (NYSE: AV) and 3Com Corp. (Nasdaq: COMS). Duke sees this purchase as a chance for Cisco to build on its lead.

Specifically, SignalWorks can help Cisco fix a big problem in IP telephony gear: the poor quality that continues to dog many VOIP devices.

"Any IP phone has echo issues," says analyst Irwin Lazar of the Burton Group. He says his firm adopted a VOIP service in-house last year, one that used Cisco phones. (Cisco downloaded SignalWorks software into its phones only within the last six months.) The provider had to add extra echo cancellers in its network to stop noise on the line.

All this took the carrier extra time and talent, Lazar says. If Cisco can perform echo cancellation right in the handset, the considerable cost savings carriers should see might spur them to roll out more services.

Others agree. "We've done a lot of end-user research on IP telephony, and call quality is by far the single biggest concern," says Chris Neil, research director at Sage Research Inc. He says anything Cisco can do in the way of improving call quality and reliability will boost its presence in VOIP -- and doing that, in turn, will help show Cisco's serious about IP voice technology.

Cisco needs a technological edge to batter stiff competition from other big players -- those with lots of carrier influence, such as Alcatel SA (NYSE: ALA; Paris: CGEP:PA), LM Ericsson (Nasdaq: ERICY), and Nortel Networks Corp. (NYSE/Toronto: NT). Nortel, for one, had its own recent flurry of VOIP announcements (see Nortel Targets Carrier VOIP Migration).

Cisco's shares were trading at $14.29 early this afternoon, up $0.09 (0.63%). Separately, the company today announced a plan to buy back $5 billion of its common stock, an extension of the $8 billion already committed for buyback (see Poll Paints Bright Future for CWDM). The repurchase is seen as positive by at least one analyst. In today's note, Lehman's Luke calls it "a constructive approach, given the indications of a continued softness in general business conditions."

— Mary Jander, Senior Editor, Light Reading