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 | 7:52:42 PM
re: Was Cerent Worth It? ...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...

I think the 454 is a great product but your analysis is completely fuzzy. You would need to calculate the 454's contribution to net income or cash flow to determine whether it is accretive to earnings. It's premature to pass judgment on the Cerent acquisition, but if CSCO's stock continues to slide, we could all be eating our words. It depends on whether the 454 is contributing to earnings.

optical schmoptical 12/4/2012 | 7:52:40 PM
re: Was Cerent Worth It? csco,

The 10% is accounted for. If i remember correctly, the stock price at the time of the deal was right around $62. The 100M shares were for the 90% that was outstanding. Meaning that Cisco payed $6.2B for 90% of the company, giving a total value for the company of about 6.9B. The other comment about the stock split is also correct. All these numbers are pre-split, meaning that the current value of the deal is about 3.3B

Edog_1 12/4/2012 | 7:52:39 PM
re: Was Cerent Worth It? The Cerent acquisition was only one small part of Cisco's overall optical and carrier-oriented strategy. Although the Monterey debacle and the Pirelli long-haul product problems were referred to in passing, I'm surprised that there was no mention of these happenings in detail. And why no discussion of Qeyton? Word on the street is that this group's integration into the "Cisco Way" is going very poorly and some rumors tend toward a Monterey-like amputation. Yes, when one focuses on Cerent alone, I can see why some would tout success; but when one looks at their optical strategy as a whole, the word "failure" comes to mind.
lightmaster 12/4/2012 | 7:52:38 PM
re: Was Cerent Worth It? RTFM,

You said :

"If cerent gives them revenues of over 700 billion, they are doing reasonably well with it."
(I assume you meant 700M not billion).

I totally agree that the issue is not absolute price, but whether it is accreditive to earnings. However, your your analysis addresses revenue, not earnings. That assumes margins equivalent with their core business. Margins on the 454 are running somewhere around half that of their traditinal business (routers), which means they must sell 1.4 billion per year before the aquisition is not dillutive to earnings.

This may not be an "exact" analysis, but you see the point. Cisco has not approached that level yet, and the 454 revenues are going the wrong way.
HarveyMudd 12/4/2012 | 7:52:38 PM
re: Was Cerent Worth It? Cisco paid a lot of money for Cerent. Cerent has nothing new. Cisco may be some money on this product because of its marketing gimmicks and fooling the customers.

Ciscop share in the opticalk market is less than 1%. There is nothing that Cisco can do to improve the numbers.

Cisco would not have entered the optical arena if Lucent was strong and did not have incompetent management.

Any Cisco is now a history. It can win the game by changing the coaches.

The recent management team consisting of Mazola and other cronies would not succeed in the current market place.
Scott Raynovich 12/4/2012 | 7:52:35 PM
re: Was Cerent Worth It? ABC this: I fixed it. Simple error. Thanks for pointing it out.
Scott Raynovich 12/4/2012 | 7:52:35 PM
re: Was Cerent Worth It? "accreditive?"

flanker 12/4/2012 | 7:52:34 PM
re: Was Cerent Worth It? "accreditive?"

From a strategic perspective, perhaps the Cerent purchase was a win, but I doubt it can be argued that the acquisition was accretive to earnings. If there are any analysts or CSCO finance geeks out there, enlighten us.

One might argue that the 454 product resulted in contract wins for other Cisco gear.
[email protected] 12/4/2012 | 7:52:33 PM
re: Was Cerent Worth It? I recently read a CIR report that indicated that Cisco was doing well with the RBOCs in terms of getting some significant account traction with the Cerent product line. If this is true then Cisco has done something that the following companies:

Sycamore (sorry, the BellSouth NAP doesn't count)

and all of these Metro Ethernet jockeys have failed to and that is to impress the customers in RBOC accounts. Nortel, Lucent and Fujitsu have fucked up their accounts, ONI is not through Osmine yet and neither is Sycamore. (Not to mention that there are rumors of a shrinking sales staff and a bad history with RBOC accounts at Sycamore)

Was Cerent expensive? If monopoly money means anything to you then, yes. But Cisco is beating other companies to the punch with the key accounts and that counts for an awful lot in today's world.
Light_Path 12/4/2012 | 7:52:33 PM
re: Was Cerent Worth It? Why is the Pirelli acquistion always referred to a "failed, misguided, unsuccessful..."? I have heard that they have over 25 paying customers and were the first to deploy OC-192 in NA. In addition, their first attempt at OOBFEC was better than most (+7dB gain). Connecting end-to-end Cisco routers with a credible Cisco DWDM seems a simple choice. How many paying customers do the new DWDM vendors have? Corvis, Sycamore.......
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