Cisco's Learning Experience

Cambrian Communications LLC's recent bankruptcy raises new questions about Cisco Systems Inc.'s (Nasdaq: CSCO) history of lending out large amounts of vendor financing to startups interested in buying its gear.

The big question is: What was Cisco trying to accomplish when it either invested in young carriers or lent them money so they'd buy Cisco gear?

Cisco differed from its large equipment carrier peers in two regards: First, it had a vendor-financing model targeted mostly at smaller startup CLECs. Second, Cisco's vendor financing has been more conservative than that of its peers. During the later half of 2000, at the height of the bubble, Cisco had $2.4 billion committed to carrier equipment loans compared to the $7 billion in commitments extended by Lucent Technologies Inc. (NYSE: LU).

In the end, Lucent was burned far more by its high levels of vendor-financing than was Cisco. Cisco was playing with smaller amounts of money it could afford to lose in each instance. Cisco has more than $21 billion in cash and investments, while the amount of money it has currently available for use by carriers -- if they meet certain conditions -- is currently about $1 billion.

But even if there's little to lose from vendor financing, does that mean there's much to gain? Indeed, a glance at just a few carrier failures this year shows that Cisco's vendor-financed successes are few and far between.

Sigma Networks, for example, was shut down in January, less than a year after announcing it had received more than $435 million in equity and debt financing from several investors, including Cisco.

In its May bankruptcy filings, Velocita Corp. listed Cisco as a creditor that it owed more than $740,000. In 2001, Cisco invested some $200 million in Velocita through a purchase of senior preferred shares, according to Velocita's Securities and Exchange Commission (SEC) filings. The carrier also agreed to buy $225 million worth of Cisco gear by May 2003 with the condition that it could be billed for whatever it didn't purchase.

Did the investment reap big returns? Not yet.

As of about three months before it filed for bankruptcy, Velocita had only bought about $63 million worth of Cisco equipment and services. About a month after Velocita's bankruptcy filing, two Cisco executives -- Ammar Hanafi and William Nuti -- resigned from Velocita's board.

Another example, as reported yesterday, is that of Cambrian Communications LLC, one of the most highly-touted Cisco-financed networks. The company is now restructuring its debts, which include $69 million owed to Cisco. Cambrian joins Advanced Radio Telecom Corp., Pacific Gateway Exchange, ICG Communications Inc., Rhythms Netconnections, Digital Broadband, Winstar, Viatel Inc., and others that have taken financing, loans, or generous equipment leases from Cisco only to end up in bankruptcy court later.

One thing Cisco does gain from this, analysts say, is that it learns more about the telecommunications business, a relatively new market for Cisco. It also serves as a convenient way of creating revenue growth for itself in new markets while at the same time making its gear more attractive to carriers.

"Cisco initially provided customers with financing to help speed adoption of new technology and further advance Cisco's role in what was, at the time, a rapidly growing market," says Martina Moscone, a Cisco spokeswoman.

Of course, vendor financing can't make a square peg fit a round hole. Cisco had, at one time, committed up to $16.25 million to finance equipment for Nucentrix Broadband Networks, but Nucentrix says it opted not to use the facility or the Cisco gear it covered. Though it completed field trials with Cisco's fixed wireless gear, the carrier later said it didn't think Cisco would stay committed to an MMDS wireless product line, according to Curtis Henderson, Nucentrix's senior VP and general counsel.

Other carriers are rethinking their vendor-financing arrangements, thanks largely to the economic downturn, which is causing carriers to slow their network buildouts (even the vendor-financed ones). In 2000, Cisco commited $50 million in financing to Primus Telecommunications Group Inc. to fund equipment purchases. In March 2002, however, Primus said it would pay Cisco $6.5 million in cash and gave it 1.2 million shares in order to settle its remaining $15.3 million lease obligation.

iBasis Inc. (Nasdaq: IBAS) did a similar thing. At one time, Cisco had committed up to $90 million in equipment leases to iBasis. Last month, however, iBasis announced it paid "its vendor" $28.5 million in exchange for the elimination of $63.8 million in existing vendor debt, future interest obligations, and other fees. IBasis never named the vendor in question but has previously stated in its SEC filings that it purchases "substantially all" of its Internet telephony equipment from Cisco. IBasis didn't return calls seeking comment.

It's tough to know whether Cisco's vendor financing has paid off. The company won't comment on specific companies it has financed, and it refuses to break out how much of its quarterly revenues come from the purchase of service provider gear.

— Phil Harvey, Senior Editor, Light Reading
lilgatsby 12/4/2012 | 9:42:54 PM
re: Cisco's Learning Experience CSCO had the cash to buy potential long-term business and grow the 15454 customers. Why not? Otherwise it would probably still only have the 200 customers that were existing Cerent customers along for the Cisco ride.

Companies like NT, LU and MONI that pulled this stunt should be the ones under the microscope. They never had the cash/debt ratio (like CSCO) to take that risk and over-extended far too much in my opinion.

I wonder how all the companies that had to actually PAY for their hardware feel about this ridiculous practice? It also seems odd to count this as "real" revenue...but that's the game.

hitekeng 12/4/2012 | 9:42:48 PM
re: Cisco's Learning Experience Cisco has been quite aggressive in buying out CLECs deals and they can still afford it!!! We worked with "SIGMA NETWORKS" for quite a while to have them scale down their proposed network rollouts from 10 to 5 tier-1 cities and proceed with a fully funded business plan as a "pre-condition" to vendor-financing. Cisco came in from left field, financed the original "non-funded" business plan and even financed the purchase of Ciena's Coredirector as part of ONS15454-based networks in all 10 tier-1 cities (interestingly enough, Cisco also financed some of our equipment for the network buildout of a flagship city). Sigma folded recently...
BobbyMax 12/4/2012 | 9:42:44 PM
re: Cisco's Learning Experience Regardless who started vendor backed financing. it is called loan sharking. Even if it turns out the equipment does meet the service providers criteria, they would be forced from the vendor that provided the financing. Also, in many equipment suppliers charge in the range of 150% more than the equipment is sold to non-financed vendors.

This kind of activity violatesthe doctrine of fair selling.
beowulf888 12/4/2012 | 9:40:21 PM
re: Cisco's Learning Experience BobbyMax:
Do you call a mortgage loan-sharking? I don't know how long the terms of the agreement were, but, conservatively, if they 5 years with a 10 percent interest rate, yeah it would add up 150 percent of what it would have cost 'em to outright buy the equipment. That is definitely not loan shark behavior. Cisco modeled their program after GE Capital. Debt is the American way ;-).

And where did you hear about the "doctrine of fair selling"? It's certainly not a legal term.

Finally, Cisco always had a very liberal return policy (although they may have tightened it up recently to prevent abuse).


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