M&A's New Currency

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gbennett 12/5/2012 | 2:31:23 AM

re: M&A's New Currency Comrades,
Open question to you all.

My feeling is that this breaks down into two threads - Carrier and Manufacturer.

Don't know much about carrier acquisitions, so I'll only comment on manufacturers.

I'm having a hard time recalling a successful acquisition. I certainly haven't experienced any from the inside (in nearly 20 years of working in this business).

Cisco is generally cited as having the best ROI for acquisitions. But I'd like to challenge this opinion by choosing what I think are the three most successful moves Cisco has made in this area.

Early 90s: Kalpana (10/94, $240M)) and Crescendo (9/93, $89M). These two acquisitions catapulted Cisco into the LAN switch market, created what became the Catalyst product family, and eventually led to the majority of Cisco revenues coming from switches, not routers. There's no doubting that these acquisitions were vastly cash-positive for Cisco.

But was it better to acquire than to develop internally? As I remember Crescendo was an FDDI switch, a small part of the total LAN switch market back then, and would be out-paced by Fast Ethernet as a backbone technology. My guess is that Cisco could have developed a multi-purpose, FDDI/Fast Ethernet switch internally, and with an IOS that looked the same as its routers. Catalyst IOS still looks different ten years later!

Ditto for Kalpana. A good switch, and the market leader at the time. But the Kalpana was a cut-through Ethernet switch, a design that dows not lend itself to speed changes. Since Fast Ethernet was just about to hit the market big time, was this the right architecture to use? Could Cisco have developed a better 10/100 switch internally, in not much more time than was needed to complete these acquisitions?

Maybe not. Synoptics (acquired by Wellfleet in 1994) proved that it's possible to get an Ethernet switch design wrong more than once. Maybe it was better for Cisco to take on a sub-optimal, but working product, than to shoot for perfection with the risk of missing entirely?

End of the 90s: Cerent (8/99, $7B). Acquired at the height of the bubble. Cisco are unlikely to recover the acquisition cost of Cerent in revenues, never mind profits. But here we can argue that the acquisition was "strategic" - launching Cisco into the carrier space (just as this market was about to plunge into recession, of course).

Clearly the Cerent platform hit the sweetspot in DS-3 interconnect market. But would Cisco have been better off developing a more general purpose optical switch in-house? In hindsight we can categorically answer no, because a market would not have appeared for such a product for several years. but in that case we'd have to conclude that the Cerent acquisition was also a bad move, wouldn't we?

And remember, these are the best examples of acquisitions I can come up with. I'd be very interested to hear opinions on this topic.

Cheers,
Geoff

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searcher72 12/5/2012 | 2:31:21 AM

re: M&A's New Currency Do companies like Cisco perform audits to determine the value or how successful an acquisition is or has been to the company either revenue, profit, market share, ease of integration into the larger company and ability (in some cases) to continue to ship product. Possibly come up with a scale that allows them to rate one acquisition against another and each business unit's ability to maintain or lose efficiency after an acquisition. Maybe if you had an index like this you could determine which acquisitions were worth it.

The reason I am asking is that during the acquisition fever it doesn't appear that anyone really took the time to stand back and ask the question that gbennett raises and yet they continued to acquire.

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routethus 12/5/2012 | 2:31:20 AM

re: M&A's New Currency Geoff,

Your comments (regardless of what you actually believe) seem to infer that acquisitions are mostly/always offensive rather than defensive ;-)

cheers.

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PO 12/5/2012 | 2:31:18 AM

re: M&A's New Currency Good questions, Geoff. A few comments, with possibly more to come (unless others get facts out sooner than I can research them).

Your examples certainly suggest that the bigger the acquisition the less likely it will be demonstrably successful. I'm quite sure, though, that many of the smaller acquisitions (by Cisco and by others) have been more clearly successful. Unfortunately, even these are tough to find good data on.

Then there's the question of alternatives. You point out the possibility for the acquiring party (or 'surviving' entity for the Merger of Equals approach which was favored for accounting reasons) doing an in-house development instead. And you acknowledge the commensurate product risks. But sometimes it's about the benefits to the acquired party: channel to market, cash influx, etc. I don't have any data here yet either, but we should be able to hypothesize on some of the stories.

Often, this is lumped into the general category of "strategic acquisitions", or may be pursued as a partnership (if control issues can be worked out).

Finally, there is the question of the currency being used. Often, the acquisition is not being done with the company's cash, but with the shareholders' equity: although the shares are being diluted the shareholders hold a stake in what should be a larger company. (And which, according to the intentions governing accounting of "Goodwill", is greater than just the sum of its parts.) So the question is not whether the profits can be used to pay for the acquisition but rather whether the profits of the combined company are "better" (ROI, ROE, P/E, whatever is popular) than the profits of the acquiring company alone.

Perhaps someone else will contribute examples before I find any actual samples ...

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optoslob 12/5/2012 | 2:31:17 AM

re: M&A's New Currency Cisco's market Cap is $181B enought said, the market has voted!!

optoslob

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dljvjbsl 12/5/2012 | 2:31:16 AM

re: M&A's New Currency
Could Cisco have developed a better 10/100 switch internally, in not much more time than was needed to complete these acquisitions?

My experience with internal development is that it is very difficult to get an existing team to do anything genuinely new. My experience is that they always end up failing because they try to relate what they are doing to what they have done before. After all they were very successful previously and see no reason why they should risk that by doing either new things or things in a different way. Job security and status issues all argue against the new project.

I have seen at least three internal development project founder because they were taken over by the existing culture within the company. The one that I saw succeed succeeded because the principals, from the start, saw it as a subversive ad hoc project that needed to protect itself from the existing culture. It was run in competition with a conventional project that had been officially sanctioned. The ad hoc project succeeded because it accepted that there was a need for change and that effective ideas could found in unexpected places. It was not kept secret but actively sought out the support of senior executives.

Remarkably the efforts of the sanctioned project helped the ad hoc project succeed. The comparison between the proposals aided the ad hoc project by showing that the sanctioned project's rehashed ideas were tired and did not fit either the technological and customer context of the day. No minor fiddling of the existing design could fix its limitations. A new way of doing things was required and the ad hoc project showed this possibility.

The books on innovation that I have read seem to echo this. They emphasize how new innovative developments must be protected within an organization. They recommend external development either in a separate location within the same company or within a new company. Even with this, the protection of a powerful executive patron is required. Acquisitions would seem to fall within this second category.

In any event doing something new is a very difficult task to bring about in a large company. Cisco's success in doing this is remarkable.

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rbkoontz 12/5/2012 | 2:31:10 AM

re: M&A's New Currency It is painfully obvious to me, having been intimately involved in several acquisitions, that they fail to meet business objectives over 95% of the time. The biggest factors seem to be cultural incompatibility and failure to execute post-deal with reduced financial incentives.

So why would anyone ever acquire a products or technology vs organic development. The biggest attraction here comes down to accounting. Public companies often cannot sacrifice profitability for prolonged periods to sustain large numbers of organic development projects. The executive decision makers of public companies are under quarter by quarter pressure and risk their jobs to take any different stance. The attraction to use stock-holder dillution to bring a product to market vs. sustained internal investment (and quarterly financial losses) is clear. This factor is highly responsibible for the existence of the venture capital industry.

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uno04 12/5/2012 | 2:31:09 AM

re: M&A's New Currency >>So why would anyone ever acquire a products or technology vs organic development.

It has come to the point where in-house development (whether there is man power or not) is not appealing to the board and the management. The baord and the management would rather let good and hardworking people go and do a buyout than develop anything new inhouse. Also, even if the M&A has proven to be a total failure, the business cycle is so long, it gets forgotten and there is no accountability at all.

Can anyone tell me any of the following M&A have brought anything to the buyer:
Cisco/Stratacom
Ciena/Cyras
Redback/Sierra
LU/Ascend

But for the stock holders, do any of the people who made the decision got affected?

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PO 12/5/2012 | 2:31:09 AM

re: M&A's New Currency I still don't have better data on Cisco's stable, but they seem to still be carrying $4B of Goodwill on their balance sheet: under FASB 142 this should be their best valuation of acquired assets (over direct value). Unfortunately, since Cisco was always so fond of the Pooling of Interests method of accounting, it's all but impossible to make any useful interpretation of this fact.

What defines a successful acquisition? I'm more familiar with Nortel's kicks at the can than I am with Cisco's, so I'll discuss them instead.

It has been generally agreed that Nortel's acquisition of the OPTera product has been highly successful by most any measure. But there has been more debate about whether the prior in-house development could have been as good or even better.

In this case, much of what was bought was a new name in the marketplace: none of the acrimony attached to Nortel products carried over to the acquisition, yet the full weight of Nortel's capability to support a product was available. Had they passed on the company, their internal product would have had to compete for the same sort of positive messaging which startups tend to generate. And they would have left a strong competitor standing against them in the marketplace.

And then there's the internal politics, where the proven people from a previous product rarely know what it really needed on a new product: those who know are rarely followed until it's too late. An acquisition is also free of that sort of history.

Nortel had made some other reasonably good acquisitions, such as Shasta and (more controversially) Bay Networks. The former probably could not have been developed in-house; without the latter Nortel would not be where it is today.

----
For an introduction to FASB 142, see ...
http://www.appraisaleconomics....

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whyiswhy 12/5/2012 | 2:31:09 AM

re: M&A's New Currency Good point about M&A in general, but misses the real attraction.

Incremental R&D expenditures and incremental progress (or the lack thereof) are very hard to keep selling to Wall Street. Not at all sexy. Very risky, takes too long, depends on engineers (egad! geeks!) and/or production (tisk tisk - the poorish-boorish...).

It is much easier to spin and flip an M&A deal, with insiders (the investment bankers and the execs involved) all cooperating to screw JQ Public.

Just like VC's, but add one or two orders of magnitude to the deal size.

JMHO

-Why

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