France's Technicolor has agreed to buy Cisco's ailing set-top box (STB) unit for €550 million (US$604 million) in cash and stock, arguing the deal will boost its market position globally.

Technicolor's share price had soared by 20% on the Euronext Paris exchange this morning following news of the deal and with Technicolor reporting a strong set of earnings for the first half of the year.

The unit being sold is expected to generate about $1.8 billion in revenues this year but appears to have recently lost out to competitors, with Cisco Systems Inc. (Nasdaq: CSCO) reporting a 12% fall in revenues from its entire service provider video business in the nine months to April this year, compared with the year-earlier period. (See Cisco Earnings: Carriers Cast Shadow Over Sunny Quarter.)

In a filing with the US Securities and Exchange Commission, Cisco then blamed the slump mainly on "lower sales of set-top boxes."

Explaining its decision to sell the business, which develops both set-top boxes and home gateways, Cisco said it believes the unit needs "a new approach to business strategy, organization model and investment."

However, it is certainly not exiting the video business entirely, having also announced a new strategic partnership with Technicolor (Euronext Paris: TCH; NYSE: TCH) that will see the two companies collaborate on the development of video, broadband and Internet of Things services.

As part of that agreement, the companies have signed what they describe as a long-term patent cross-licensing agreement.

"We have the right company in Technicolor to drive the future of the CPE [customer premises equipment] business to deliver what our customers and partners need, today and into the future," said John Chambers, Cisco's departing CEO, in a company statement. "We are prioritizing our investments to deliver on our strategy of video in the cloud, and will partner with Technicolor to position the CPE business and employees for future success." (See Cisco's Robbins to Replace Chambers as CEO.)

Cisco is to receive €413 million ($454 million) in cash and €137 million ($151 million) in newly issued Technicolor shares through the transaction, which is expected to close late this year or in early 2016.

The French company reckons the takeover will double annual revenues at its connected homes business to about €3 billion and increase EBITDA to more than €200 million ($220 million) next year.

Technicolor made €77 million ($85 million) in adjusted EBITDA at its connected homes business last year, 5.6% more than in 2013.

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Following the deal, it expects to have a global market share of about 15% of the CPE business, shipping around 60 million devices every year, compared with about 34 million in 2014.

It has also indicated the acquisition should generate synergies of about €100 million ($110 million) annually thanks largely to the consolidation of supply-chain activities and a reduction in selling, general and administrative expenses.

Technicolor is to fund the purchase through a mixture of cash on hand and new debts but insists it will have a limited impact on its balance-sheet position, having reported a net-debt-to-EBITDA ratio of 1.18 last year.

In a separate earnings announcement, Technicolor revealed that net income rose to €50 million ($55 million) in the first six months of the year, from €29 million ($32 million) in the first half of 2014, with revenues up 8.4%, to €1.62 billion ($1.78 billion), over the same period.

Even so, Technicolor flagged "softness" in the connected homes business during the April-to-June period, with first-half revenues falling by 0.5%, to €652 million ($716 million), compared with the same period last year.

It expects these conditions to persist in the third quarter but is guiding for a strong recovery between October and December and reckons it will grow "materially faster than the market on a full-year basis."

Cisco first entered the STB market about ten years ago when it paid about $6.9 billion for Scientific Atlanta , a developer of cable equipment as well as CPEs.

Since then it has made about $27 billion in total from the sale of connected devices, according to Hilton Romanski, Cisco's senior vice president and chief strategy officer.

Romanski is to join Technicolor's board of directors as part of the agreement between the two companies.

— Iain Morris, , News Editor, Light Reading