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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rtfm 12/4/2012 | 7:52:32 PM
re: Was Cerent Worth It? Yes, I meant 700 million, not billion (should have been obvious).

I also fully agree with people on revenues being accretive as an important measure, but I don't know (or won't say ;) specific breakdowns on margins on different product lines. However, one can guess that new product lines can often have lower average margins given lower volume, high customer acquisition costs (including vendor financing), and hopes of moving along the production learning curve. (Of course, Cerent smashed then prevailing pricing for SONET gear, so often part of newer equipment means lower sale prices with only similar margins as "traditional" equipment).

As for margins on product lines, one always has to expect a range (probably more lognormal than bell-curve). No company can just keep the top *earnings* contributers. Their earnings might not grow as much, and someone else out there will always try to pick off that cherry (Juniper, anyone?) In addition, a wide product line is attractive to many users.

The question is did Cerent's margins improve over the last few years? One has to also remember that this is a vastly more competitive space than, say, core routers.

In addition, just like playstations or TiVo, I don't think the big bucks are made on the initial hardware sale. It's repeat buys by existing customers and more than that the line cards where the money is.


"A billion here, a billion there, pretty soon you're talking real money." - Senator Everett McKinley Dirksen
khastings 12/4/2012 | 7:52:30 PM
re: Was Cerent Worth It? I can see from looking at enterprise value/EBITDA ratios for CISCO as posted on www.Triene.com that the company is trading high and still poised for additional acquisitions. What is driving this high cashflow multiple?

oc-3072 12/4/2012 | 7:52:30 PM
re: Was Cerent Worth It? can someone do a quick calculation to figure out what price CSCO would have to pay for CIEN for the acquisition to be accretive to 2002 earnings?
try_again_please 12/4/2012 | 7:52:27 PM
re: Was Cerent Worth It? I have heard that Turin Networks is building a platform that is similar to the Cerent box, but with Next Gen capabilities and better density. Don't know if that's true or not as I can't find any real info on them, but was wondering if anyone else did? I think that the Cerent box has done what it was designed to do, but don't know if it will go much farther than that.

flanker 12/4/2012 | 7:52:27 PM
re: Was Cerent Worth It? can someone do a quick calculation to figure out what price CSCO would have to pay for CIEN for the acquisition to be accretive to 2002 earnings?...

There is a problem here because Cisco's earnings have slowed at a more pronounced rate than Ciena's. Cisco took a very big noncash charge that LR reported. This really screws up net income based estimates.

Based on CSCOs crappy earnings performance, they could probably offer a premium to Ciena without diluting earnings, but I dont know where the upper limit is becuase of all the non cash garbage floating around in CSCO's income statement.

You also forget that a high premium suggests CIENA shareholders would have a lot of influence in a emerged comapny, something that Cisco would not like. I disagree with the last post that Cisco's share price makes acquisitions attractive.Any announcement would push CSCO's shares down, requiring Cisco to issue even more shares in a merger and losing that much more control to the other company's shareholders.

lightmaster 12/4/2012 | 7:52:25 PM
re: Was Cerent Worth It? try_again_please asked:

"I have heard that Turin Networks is building a platform that is similar to the Cerent box, but with Next Gen capabilities and better density.

Going purely by what you state above, Turin can join a long list of others who say exactly the same thing, including Redback (SmartEdge), Cyras (Ciena), and 20 others.

Strangely, Turin told the world that they were going to publicly unveil their product at NFOEC, then failed to do so (either that or it was so uninteresting that nobody wrote about it, which I doubt). So until they come clean with what they are really up to, they get to stay in the pile with all the others.

tsunami 12/4/2012 | 7:52:23 PM
re: Was Cerent Worth It? "If this is true then Cisco has done something that the following companies:
and all of these Metro Ethernet jockeys have failed to and that is to impress the customers in RBOC accounts."

The CIR report you are quoting from is either wrong or you misunderstood. Amoung the vendors you mentioned as failing, the three vendors above have dominated the RBOC accounts for the last ten years with Fujitsu alone accounting for ~60% of all RBOC tranmission sales. Fujitsu still ships in a week more then all Cisco transmission sales combined to RBOC accounts. Cisco's sales have been to CLECs, CAPS and new carriers and only recently entering into RBOC.
[email protected] 12/4/2012 | 7:52:22 PM
re: Was Cerent Worth It? Let's see...

Fujitsu's sales numbers are down substantially and not just because we are in a bad economy. Ask around and you will hear bad stuff about their products and software. Nortel and Lucent have also not done a wonderful job in terms of product quality or reliability. Cisco is, in fact, making inroads into the RBOC accounts with the Cerent product. What will the total $$$ be? Not sure yet but MY POINT was that Cisco is getting traction and that could make the acquisition very much worth it in the end. I Never said that LU, NT or Fujitsu were going out of business. Just that they were screwing up in their accounts. The quotes in the report were from RBOC network people.

I am sorry if you work for Fujitsu. I hear that they have leadership problems as well.
Lighteating 12/4/2012 | 7:52:21 PM
re: Was Cerent Worth It? This is a tangent to the thread but I wonder if anyone knows which investment bank handled CSCO aquisitions.

Thanks in advance.

tsunami 12/4/2012 | 7:52:21 PM
re: Was Cerent Worth It? I don't work for Fujitsu, but I know which suppliers are successful with RBOCs and it ain't Cisco just yet. The main issue with Cisco gaining market share from Fujitsu/Lucent/Nortel is that Cisco has never mastered the keys to selling into RBOC accounts. Cisco's management grew up dominating the enterprise data market while the big three grew up selling to RBOCs. Cisco still trys to sell by domination and that doesn't work with RBOCs. Cisco latest round of reorgs points to the fact they are struggling with this very fact but I'm not sure they have the depth of talent to manage dominating the enterprise data world and the RBOC transmission world - my guess is not.
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