Was Cerent Worth It?

After the implosion of Lucent Technologies Inc.'s (NYSE: LU) Chromatis venture, it makes sense to reconsider another high-profile optical equipment acquisition: Cisco Systems Inc.'s (Nasdaq: CSCO) 1999 purchase of Cerent Corp. for about $6.9 billion in stock (see Lucent Ditches Chromatis).

Was it worth it? Yes, even though Cisco probably won't see a full return on its investment for quite some time.

With the acquisition, Cisco kept Cerent's next-generation Sonet add/drop multiplexer out of its competitors' hands, using its sales and marketing muscle to move more than 30,000 systems out to some 600 customers in a little more than two years.

Cisco paid 100 million shares for Cerent back in August 1999. Those shares, which were worth some $6.9 billion then, are worth about $3.2 billion now, when adjusted for a two-for-one stock split in the spring of 2000. "Everyone paid too much for everything in the last couple of years," deadpans Dave Dunphy, Senior Optical Infrastructure analyst at Current Analysis .

The success of the products that came from the Cerent acquisition, especially Cisco's ONS 15454, has helped give the enterprise-focused equipment company a toehold with carriers and service providers. That paved the way for Cisco to ship some 500 units of the next Cerent-based product, the ONS 15327, to more than 80 customers since it was introduced in January.

By other metrics, however, Cisco's roaring success has some blemishes. For one thing, with service provider spending slowing and becoming more concentrated, there's no telling when Cisco's going to make its money back. CIBC World Markets estimates that Cisco's ONS 15454 product pulled in about $100 million in revenues in 1999, $700 million last year, and will likely contribute between $400 and $500 million this year.

Infonetics Research Inc.'s Michael Howard has a more optimistic take. He says the ONS 15454 pulled in about $900 million in revenues last year and, thanks to European sales, upcoming OC192 (10 Gbit/s) functionality, and some added Ethernet ports, it might do at least that or even better this year.

Of course, it's not known how much of that will turn into Cisco profits, and there's no telling how much vendor financing it took to win some of those sales. It's also hard to tell how much of Cisco's optical equipment customer base is solid. There's no doubt that quite a few of the 600 customers Cisco touts in that area have gone under (see Cisco's Under-Powered Carriers ).

"We estimate that about 40 percent to 50 percent of [Cisco's] carrier business comes from emerging carriers," wrote Lazard Frères & Co. LLC analyst Truc Do back in May. "This exposure will likely hurt Cisco's carrier growth due to a lack of funding."

Nonetheless, Cisco has a defensible market, and it has enjoyed a big headstart on its optical transport competitors such as Redback Networks Inc. (Nasdaq: RBAK), Ciena Corp. (Nasdaq: CIEN), Metro-Optix Inc., and White Rock Networks. "Though the challenges in this area are becoming tougher, I don't think the ONS 15454 is a threatened platform," says Dunphy of Current Analysis.

One lingering question, though: How well will Cisco be able to capitalize on the success of its Cerent-created installed base? Given that it has dropped out of the core switch market, and its long-haul DWDM product hasn't taken significant market share, there is a limit to what service providers can expect from Cisco.

Even Cisco's Optical Transport Business Unit is going through a change following Cisco's recent management reorganization (see Reorg Rips Through Cisco's Ranks). Former Cerent CEO Carl Russo handed over operations responsibilities and, though he's denied that he's going anywhere, rumors persist that he's already negotiated a November departure.

Further, former Cerent employees continue to turn up at startups in and around Petaluma, Calif. Some of the top brass at Calix Networks, where Russo holds a board seat, are former Cerent executives. And one of Cerent's top engineers, Paul Elliott, recently parted ways with Cisco.

"Relative to its time, Cerent was one of the more successful acquisitions," says Salomon Smith Barney's Alex Henderson. "But, though Cisco has had blotches of success, overall, I don't think they've done a great job in penetrating the service provider market."

— Phil Harvey, Senior Editor, Light Reading
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flanker 12/4/2012 | 7:52:50 PM
re: Was Cerent Worth It? If CSCO paid in shares you may as well mark down the value of the stock to where it stands today, as well as adjust for stock splits. Given where Cisco stock is trading, they paid a lot less than $6.9bln.

It's not Cisco's cash flow that got hurt, it's share holder dilution that an investor should be concerned about.
csco 12/4/2012 | 7:52:50 PM
re: Was Cerent Worth It? Cisco had a stock split since after the
acquisition, so they paid 200 M in todays
shares for Cerent which is worth about 3.3B

Also one point was never clear about the
purchase price.
Cisco was already a 10% owner of Cerent. So did
the purchase include that 10% or not ?
So was the real purchase price 6.9B-10% ? or
6.9B+10% or exactly 6.9B ?

optical_999 12/4/2012 | 7:52:49 PM
re: Was Cerent Worth It? The word on the street from Calix Sales is that Calix is developing the next-generation Cerent. Great port density, doing everything that Cerent does in a very small platform including ATM, IP and MPLS. I actually heard that Calix can fit one full 7 foot rack of Cerent's ports in one Calix chassis.

How can a person working for Cisco be a board director of a potential competetion? How does this work? Is Carl ending up in Calix?
skeptic 12/4/2012 | 7:52:49 PM
re: Was Cerent Worth It?
Cerent was very much "worth it". It was paid
for with inflated stock. The true cost to
cisco was very low. And in exchange, they
were able to enter a business that they would
not otherwise have been able to get into. They
invested inflated stock into growth in their

It what way was this not a success?
csco 12/4/2012 | 7:52:49 PM
re: Was Cerent Worth It? My point was that LR has an error in the article when they say that it is worth 1.6B today
because they did not account for the 2:1 split.
"Cerent" is worth 3.3 B today not 1.6B.
Then there's the other issue of the 10% Cisco

On your other point if you go into details of
the revenue generated via Cerent versus stock
dilution you will find that csco investors
should be pleased. On top of that the value of
the foot holds made in service provider accounts is immeasurable.
myresearch 12/4/2012 | 7:52:48 PM
re: Was Cerent Worth It? Yes, I agree with skeptic here that Cerent is very much worth it. The price Cisco paid with its paper money is not a good measure. The real question is whether the Cerent box is a good product line and whether it fills in a gap in cisco's portfolio. On both critieria, the anwser is yes. Cisco's stock price would be lower if cisco did not have the cerent product and a leg in the service provider market.

If you think of the other acquisition Cisco annouced with the Cerent one (i.e., Monterey), Cerent is worth every penny:-)

In this sense, Lucent's acquisition of Ascend is a reason deal for Lucent (compared with other Lucent acquistions:-). Lucent managed to get into the data business and bought an installed base. Although a lot of people from Ascend left and Lucent could have done better, Ascend product line is still the fastest growing among all Lucent products and become one of the three core business (data, optical and switching). Ascend did manage to produce some good products after the acqusition (Stinger and new generation of P550). Lucent would be in a much worse shape without the Ascend deal.

lightpimp 12/4/2012 | 7:52:48 PM
re: Was Cerent Worth It? Great, another God Box huh? What are the odds of these guys deploying? Another Tachion in the making? The complexity of developing these MSP boxes makes the VCs cringe. The risks in the current market outweigh the rewards until carriers start buying again which may not happen again for quite sometime. Timing is of the essence. Cerent/Cisco made most of the money from the 454 right when the carriers needed that technology the most. Those times are gone.
rtfm 12/4/2012 | 7:52:47 PM
re: Was Cerent Worth It? Stock splits are an artificial accounting measure (witness Warren Buffett's Berkshire). The question remains what percent of Cisco shares was 6.9 billion at that point in time, and what is that same percent of the company worth today. Split adjusted, the price of CSCO was only about two times what it is today (so the 3.3 billion number posted earlier is quite close).

So, for about 120 billion M-cap today, and 3.3 billion "cost" (ignoring 2 years of time-value of money), we see they went through a stock dilution of some 3%. Assuming that they keep at least the previous few (reduced) quarters going, they have an annual revenue expected of about 18 billion. If cerent gives them revenues of over 700 billion, they are doing reasonably well with it. Add to this entry into a new business arena, possibly steady/growing income, and this looks even better.

This isn't to say that cerent revenues will continue ad infinitum - they need to continuously innovate (or buy!)

johnjohn 12/4/2012 | 7:52:45 PM
re: Was Cerent Worth It? myresearch,

wrt lucent being in worse shape without the ascend acquisition, that discussion should be handled over on the lucent board. many lucent folks feel as though the company lost its focus after the acquisition. the feeling was that lucent stopped paying attention to its bread-n-butter customers and opened up the doors to competitors.
freethinker 12/4/2012 | 7:52:45 PM
re: Was Cerent Worth It? In all the discussions of the "cost" of acquisitions made last year with stock priced at inflated levels, there's never mention made of the fact that the stock could have been used to acquire an asset that would not have been revalued - cash.

Imagine Cisco without Cerent today - but with another $6 billion in cash (+ or - the 10% already owned).

Imagine Lucent with the cash that could have been generated with the stock issued for Chromatis - whole 'nother ballgame.

Imagine Nortel with the cash that could have been generated with the stock issued for Alteon Web Systems.

Merely looking at the small percentage of shares outstanding that were used to purchase "assets" of dubious value or forgiving their use because the share price was insane are unjustifiable excuses of poor management choices.

The truly unfortunate thing about all of this correction from excess is that it is likely to be overdone in the other direction: good start-ups won't get funded, good private companies won't be able to access public funding and good strategic fits will probably be passed over due to lack of financial flexibility or nerve on the part of the management of potential acquirers.

The final chapter of this book is years away from being written.

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