Cisco's Creative Andiamo Options

As details emerge of Cisco Systems Inc.'s (Nasdaq: CSCO) plan to "acquire" Andiamo Systems Inc., it's clear that Andiamo was effectively a dummy company established to provide unique stock-option incentives -- which Cisco says could be worth as much as $2.5 billion in total -- to a small group of executives and engineers (see Cisco Buys Andiamo).

Cisco's entrance into SAN switching is obviously a good thing for the industry as a whole. Armed with the Andiamo switches, Cisco is poised to seriously shake up the status quo in the Fibre Channel switch market, which is currently dominated by Brocade Communications Systems Inc. (Nasdaq: BRCD) and McData Corp. (Nasdaq: MCDTA).

But its unorthodox arrangement with Andiamo continues to raise questions about why Cisco felt it was necessary to structure the deal the way it did. Why did Cisco form a separate company at all? Why were ordinary Cisco stock options not good enough incentives for those employees?

The answer, as best we can determine, is that Cisco was deeply concerned about losing certain top-flight execs unless it came up with some kind of alternative compensation scheme, seeing as Cisco's stock price had fallen precipitously from its mid-2000 highs. At the same time, Cisco was very likely finding it difficult, if not impossible, to recruit elite Fibre Channel engineers unless they too were given potentially lucrative stock options.

In a roundabout way, Cisco has said as much. The structure of the deal "allows Cisco and Andiamo to balance both the risks and rewards of new market entry, while preserving the benefits of an entrepreneurial venture," Ammar Hannafi, VP of strategy and business development, told analysts and reporters in a conference call Tuesday.

By "benefits of an entrepreneurial venture," we think Hannafi means "multimillion-dollar, dotcom-style stock payout."

Cisco has finally confirmed that it is the exclusive investor in Andiamo, a connection first reported by Byte and Switch more than a year ago (see Cisco’s Secret SAN Strategies Revealed). The supposedly independent, privately held startup has not received a penny of funding from any other entity or individual. To date, Cisco says it has invested $74 million in Andiamo through convertible debt, out of a total of $84 million in promised funding. That investment (plus an additional $100 million pledged through the closing of the Andiamo acquisition) gives Cisco about a 44 percent stake in the venture.

Who owns the other 56 percent of the "startup"? Cisco says that ownership stake consists entirely of Andiamo stock options granted to Andiamo's 270 employees, as well as to 37 Cisco employees who have been "seconded" to the Andiamo project. This means that those 37 Cisco staffers are technically employed by Cisco, but they work full-time for Andiamo.

Andiamo means "let's go" in Italian, and it's been rumored that several senior Cisco executives were threatening to tell Cisco just that unless they received some kind of special compensation. According to this theory, Cisco structured the deal for Andiamo to make sure these executives -- which supposedly included Mario Mazzola, Cisco's chief development officer -- stayed in the family.

A Cisco spokesman says that neither Mazzola nor any other Cisco officer or board member has any financial interest in Andiamo. Only Andiamo's employees and the Cisco employees seconded to Andiamo do, the spokesman says.

In that case, who is going to hit the jackpot, if and when Andiamo's switches start beating the pants off Brocade and McData? (See Cisco's Sales Strategy Unclear.)

Cisco is still being extremely secretive about who Andiamo's employees are. The only ones it has publicly named so far are CEO Buck Gee and VP of marketing Jacqueline Ross. Cisco representatives said Gee was not available for an interview, and they declined to identify any other members of Andiamo's management team.

Gee was previously VP of marketing at Com21 Inc. (Nasdaq: CMTO), a cable modem maker. Prior to joining Com21 in November 1994, he was employed by -- guess who? -- Cisco, which in 1993 acquired the company he was working for at the time, Crescendo Communications. Mario Mazzola, incidentally, was president, CEO, and founder of Crescendo. Ross, meanwhile, previously served as VP of marketing at Marimba Inc. and Check Point Software Technologies Ltd. (Nasdaq: CHKP).

Cisco did tell us that Andiamo has hired engineers from Brocade, EMC Corp. (NYSE: EMC), Hitachi Data Systems (HDS), IBM Corp. (NYSE: IBM), and Nishan Systems Inc.

Of course, the bottom-line question is: How much are shares of Andiamo actually worth? Right now, that's unknown. According to the terms of the deal, Cisco will exchange shares of its common stock for Andiamo shares (those held by Andiamo's employees). The overall transaction, expected to close sometime in the first half of 2004, could be worth as little as zero and as much as $2.5 billion, although industry observers say the final price won't be nearly that high.

Cisco argues that the Andiamo spin-in is a better deal for everyone involved, including shareholders, than if it had arranged a more conventional acquisition. Why? Because the ultimate purchase price is tied to how much Andiamo gear Cisco can sell (during an unspecified three-month period hence). Therefore, Cisco says, it will get a fairer valuation than if it had purchased Andiamo without knowing the viability of its products.

But analysts point out that under this deal, Cisco may have an incentive to not aggressively market and sell Andiamo switches so that the purchase price remains lower. Cisco's Hannafi insists the deal is based on "mutual trust" between the two companies.

"If you look at the structure and the way it's been put together, it implied a lot of trust from Cisco on the development process and the entrepreneurial ability of the team at Andiamo, and similarly from Andiamo a trust in Cisco doing the right thing for its customers," he said.

Perhaps Cisco's next challenge will be to rally its sales channels to move products that will ultimately help line the pockets of the 300 or so engineers and executives associated with Andiamo.

In an interesting side note, on Tuesday Brocade announced that Mark Leslie, former chairman and a current director of Veritas Software Corp. (Nasdaq: VRTS), has retired from Brocade's board of directors. Veritas has been working very closely with Andiamo to develop virtualization and volume management features, and it's possible that Leslie -- or Brocade -- perceived a conflict of interest in his role on Brocade's board (see Brocade Names Paisley to Board and Veritas Puckers Up for Cisco).

— Todd Spangler, US Editor, Byte and Switch

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PrivateCEO 12/4/2012 | 9:53:08 PM
re: Cisco's Creative Andiamo Options In my experience, sales people don't care where the products they have to sell come from or who gets rich in producing them. They live for commissions and the kill and will welcome the Andiamo-sourced products so long as they provide a competitive edge.
KPSmells 12/4/2012 | 9:53:08 PM
re: Cisco's Creative Andiamo Options It is interesting that the media has focussed a lot (and quite appropriately) on wall street for conflict of interest stories. I wonder why no focus on Sand Hill Road and the VC Industry ? I think lot of VCs had huge conflicts of interests that led to inflated valuations and the bubble. Lot of people lost lot of money and their retirement, thanks to conflict of interest among the VCs.
pooh-bear 12/4/2012 | 9:53:07 PM
re: Cisco's Creative Andiamo Options Cisco is still being extremely secretive about who Andiamo's employees are. The only ones it has publicly named so far are CEO Buck Gee and VP of marketing Jacqueline Ross.

Dear Lightreading,

Did you bother to look on CiscoGÇÖs public web site? More evidence of Crescendo roots:

August 20, 2002

Cisco today announced the Cisco MDS 9000 Series, a a comprehensive family of multilayer intelligent storage switches that deliver a number of storage networking innovations to customer. [email protected] caught up with two executives from Cisco's Switching, Voice, and Storage Group -- Luca Cafiero, Senior Vice President and General Manager and Soni Jiandani, Vice President of Marketing. Here's what they had to say about Cisco's new storage networking product line.


docsisdude 12/4/2012 | 9:53:07 PM
re: Cisco's Creative Andiamo Options why does everyone assume this is such a great deal for the people of Andiamo? if their sales son't amount to much, they're pretty screwed.
Iipoed 12/4/2012 | 9:53:05 PM
re: Cisco's Creative Andiamo Options PrivateCEO- please remember that every company is out there for one reason- SUPPORT SALES. If a company is operating and every person in that company does not consider themselves a sales person then I doubt they will ever be successful. IMHO
BobbyMax 12/4/2012 | 9:52:59 PM
re: Cisco's Creative Andiamo Options It is clear that Cisco's accounting practices, option awards, product pricing, and promotion principles are not being watched over by the government and industry analysts.

It is a surprising to learn that Cisco has housed Andioamo on its premises and provided staff. Based on this information, Cisco is the complete owner of the company and it can circumvent State and Federal Laws to take advantage of the purposeful chaos that it has created.

The question of promotion of four personnel in Cisco to higher level positions from a total workforce of 30 personnel from Cresendo Communications ( acquired by Cisco) is mind bogling and is unjustifiable from the perspective of governing corporate standards. In fact, a public corporation of the size of Cisco rarely behaves in this pension.

Cisco so far has not disclosed its storage products. Once the products are out, opnions will be expressed. It is not clear what Cisco could have done in making various proclaimations about its market share. It had done similar false claims regarding its market share in the optical networking industry.

Cisco has claimed that it has storage routers for LAN based SANs. It is not clear as to what it has done to make very tall claims. Cisco has a lot of LAN routers and making some minor modications would turn the old routers such as Catalyst routers into storage routers. Its per port also appears to be very high. It would also be interesting to watch how it has charged for R&D expenses when the p[roduct is a derivative of an old product.
Todd Spangler 12/4/2012 | 9:52:57 PM
re: Cisco's Creative Andiamo Options Luca Cafiero and Soni Jiandani are Cisco employees, not Andiamo employees. Cisco says they are not among the 37 Cisco employees who have been "seconded" to Andiamo.
boozoo 12/4/2012 | 9:52:57 PM
re: Cisco's Creative Andiamo Options "Cisco has a lot of LAN routers and making some minor modications would turn the old routers such as Catalyst routers into storage routers."

Can you be more specific as to what are the "minor modifications" you spoke about?

router123 12/4/2012 | 9:52:56 PM
re: Cisco's Creative Andiamo Options Could these employees have made a difference outside of cisco. In the present market scenario,
it would have made less of a difference if these
folks had quit. This is a scam on the part of
cisco. The next in line i believe is Calix. Any
smoke here ???
PacketProtector 12/4/2012 | 9:52:54 PM
re: Cisco's Creative Andiamo Options What this article doesn't mention is that many of these spin-in deals are made with very specific milestones along the way. If the milestones aren't met, the spin-in company's employees may not get anything. It is a form of protection for the parent company. Granted the parent's investment in the company may become worthless, but so too would the stock of all the spin-in shareholders.

I don't know how this deal was structured, but it may well have been *less* risky for Cisco to do it as a spin-in. It's much easier and probably less expensive to cut off funding to an outside entity than fire an entire group within the company.

In the end, if they get a good storage product on the market, it may benefit the parent company, spin-in employees, and the shareholders of both.

- P
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