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Cisco's Components Feast

Column
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Column
9/21/2000

It's been said that money can't buy you love. But in the optical networking world, Cisco Systems Inc. (Nasdaq: CSCO) seems to earn a significant amount of respect from the investment cash it's pouring into optical components firms.

In August, Cisco invested in optical components maker Oplink Communications when it bought a convertible promissory note for $50 million. When Oplink goes public later this year, Cisco will own about three and a half percent of the company, according to information in Oplink’s S-1 filing (see Oplink Opts for $172 Million IPO).

Oplink’s S-1 also states that Terence P. Brown, who served as Cisco’s vice president of optical networking sales from November 1999 to May 2000, took a board seat at Oplink in August.

This is one of several investments Cisco has made in the optical components space. Last year, when Cisco bought Pirelli Optical Systems for $2.5 billion, it also invested $100 million in the Pirelli Cables and Systems optical components business (See Cisco Puts New Spin on Pirelli).

This year Cisco has also participated in optical component investments including Cidra Corp.'s June funding round of $100 million, LightLogic Inc.'s May funding round of $57.5 million, and SiByte Inc.'s May funding round of $40 million.

There are two main reasons for Cisco’s stepped-up activity here: First, optical component makers are commanding some of the highest price-to-earnings ratios on Wall Street. Since investors are betting on some astronomical earnings growth from components makers, these firms’ share prices are heading for the clouds. Any corporation or venture capitalist that invests before said firms go public is rewarded with a big bag of money (See VCs Boost Optical Investments and The Cisco Effect -- R. Scott Raynovich).

Second, Cisco wants its portfolio companies to help it strategically by supplying products, advising it on other components, and helping with product development. In return, Cisco’s portfolio companies get a name-brand customer and the chance to be introduced to other Friends-of-Cisco, firms that might be of strategic importance.

Of course, Cisco doesn’t want to be in the components business itself. Carl Russo has said several times that since component technology becomes obsolete so quickly, Cisco feels it would be a liability to own a components maker -- even for the sake of getting first dibs on rare products.

Its competitors are also rejiggering their components businesses, but that’s more out of trying to be like JDS Uniphase Inc. (Nasdaq: JDSU) -- a components pure-play that Wall Street loves -- than trying to mimic Cisco, which is viewed by its nemeses as an optical networking infant (See Alcatel Prepares for a Components War and Hitachi Plans Component Spinoff and Lucent Names CEO for Spinoff).

Because of its willingness to help components startups prosper, Cisco will find it easier and easier to spread its influence throughout the components business as the pace of its investments increase.

“When I speak with other startups that are thinking about [Cisco’s] funding strategy, I highly recommend that they consider [taking an investment],” says Gary Wiseman, LightLogic’s VP of Marketing. “It brings incredibly positive benefits that far outweigh any potential negatives, like the reaction of Cisco competitors.”

Privately held optical components makers will do well to keep in mind Cisco’s unstated influence when it comes time to tap their next round of funding. On paper, it’s easy to make a distinction between Cisco, the benevolent investor, and Cisco, the equipment firm that looks impressive on a customer list.

However, there’s always an ever so subtle tugging to play favorites, no matter how much Cisco insists that they want to be treated like the other customers. But in business, usually you get what you pay for.

-- Phil Harvey, senior editor, Light Reading http://www.lightreading.com

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