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Optical/IP

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
http://www.lightreading.com
flanker 12/4/2012 | 7:52:00 PM
re: Was Cerent Worth It? They have 400+ GSR routers in their German IP network alone (and they had Juniper, Nexabit etc. under evaluation before deploying GSRs). I wouldn't call that being unable to sell into "old world" carriers.

yeah, but the whole point is they are not moving closer to the core in terms of market share gains. Granted LR says the extent of 454 sales is pretty good. (and i dont know where they got the number, $750mln) for annual 454 sales. I think that a bit inflated.

mboeing 12/4/2012 | 7:52:02 PM
re: Was Cerent Worth It? "...Cisco never mastered the key to selling into RBOC accounts."

Well, you're probably right if you refer to optical transmission gear only. OTH Cisco knows quite well how to sell IP gear into the incumbent operators. Take Deutsche Telecom as an example. They have 400+ GSR routers in their German IP network alone (and they had Juniper, Nexabit etc. under evaluation before deploying GSRs). I wouldn't call that being unable to sell into "old world" carriers.

/MAB.
flanker 12/4/2012 | 7:52:06 PM
re: Was Cerent Worth It? ...What many folks don't know is that among the largest systems and network integrators and resellers in the world are the RBOC's!! SBC alone is larger than EDS or Arthur Anderson, and nearly as large as some of the truly big players like IBM in the systems integration business...

Yes, and when an enterprise is too stupid to manage its own network they get taken to the cleaners!


^Eagle^ 12/4/2012 | 7:52:10 PM
re: Was Cerent Worth It? I am not sure where you get your information or ideas...; but I have years of experience at RBOC's including SBC, the PacBell SBC, Ameritec SBC, Nynex Verizon, GTE Verizon, Bell Atlantic Verizon, and US West Qwest, and I can tell you that Cerent Cisco has made insignificant traction inside the RBOC ILEC space. Those accounts are served quite well by various combinations of Fuji, Lucent, Nortel, Tellabs Alcatel for their optical transport and switching needs. Don't let any other stories fool you. this includes next gen SONET gear as well as DWDM, DXC or OXC, from core to edge. Where those big players don't own the RBOC business, you have second Teir players like ECI, Hitachi, NEC, Marconi, Ciena, AFC, owning various niche's within the space.

Cisco is far far behind any of these in transport at edge or core. And the Cerent 454 while a worthy box is still just a SONET box with a little DWDM bolt on shelf they buy turnkey from JDSU or Avanex or others. The DWDM is not even really a part of same shelf.

Cisco Cerent is incredibly vulnerable to the current downturn due to the vast portion of their business being in greenfield carriers, or greenfield sub portions of companies like MCI/Worldcomm or Qwest.

Where you might have heard something like you are describing, is that Cisco has made BIG sales volume strides inside RBOC's, but NOT for deployment of Cisco gear into BOC networks per se. Cisco has done well inside RBOC's selling routers for the RBOC internal LAN/WAN Enterprise to hook up servers and gear to run their internal network management communications infrastructure...not for hauling customer traffic. In this instance the RBOC is just like any other big enterprise customer. And Cisco is strong in the enterprise.

The other big place Cisco has done well is with the outsourcing/ system/ network integration arms of the non-regulated portions of the RBOC's. What many folks don't know is that among the largest systems and network integrators and resellers in the world are the RBOC's!! SBC alone is larger than EDS or Arthur Anderson, and nearly as large as some of the truly big players like IBM in the systems integration business. In this portion of the business, the RBOC designs and builds and sometimes operates large enterprise networks for big end users in their territories. Like state and regional government, large companies, etc. In this capacity, the RBOC's are some of CISCO's very very largest customers and resellers. The RBOC buys Cisco gear use in their enterprise customers campus networks.

This is NOT the same as penetrating the RBOC transport and switching and signalling networks.

sailboat
freethinker 12/4/2012 | 7:52:14 PM
re: Was Cerent Worth It? "...but I wonder if anyone knows which investment bank handled CSCO aquisitions."

No one - they've all been home-brewed deals.

Freethinker
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.

Cheers!!
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.
[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.
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:
...
Nortel
Fujitsu
Lucent
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.
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.
Opinions?"

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.

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.

Opinions?
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.






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?
-oc-3072
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.

rtfm

"A billion here, a billion there, pretty soon you're talking real money." - Senator Everett McKinley Dirksen
[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)
ONI
Ciena
Nortel
Fujitsu
Lucent
Alcatel

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.......
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.
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?"

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.
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.
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

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.



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.

Freethinker
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!)

rtfm
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.
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
business.

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
ownership.

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.
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
today.

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 ?

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