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Did Cisco Hand Out a Few Golden Eggs for Easter?

Cisco has been back at the acquisition game in the past few weeks and once again are paying top dollar.  On April 9th Cisco acquired Pure Digital Technologies in a deal worth $605 million — $590 million in stock and $15 million cash in retention payments.  Pure Digital is the manufacturer of the Flip Video camera popularized by the infamous Robert Scoble.  On April 10th Cisco announced the acquisition of Tidal Software for $105 million.  Tidal Software provides data center application management software that competes with BMC Software, CA and IBM’s Tivoli.

Most technology companies today have low valuations – the current financial crisis has hammered the tech market.  Typically, technology companies trade for 1x to 2.5x trailing twelve months revenues.  Yet Cisco paid some pretty hefty premiums for Pure Digital and Tidal Software:

cisco-11

 

 

 

 

In today’s market there are hundreds of prognosticators that are telling technology company CEOs and Boards of Directors that now is a great time to buy.  With technology equity prices being so cheap there may never be a better time to pick up a desirable property.  Something these same prognosticators fail to mention is that there are few companies that are willing to sell at today’s valuations unless they are so broke that they are headed to Chapter 11 in the next six months.

In the 1980’s and 1990’s the technology market was dominated by the classic consolidators – Computer Associates, Sterling Software, and Platinum Technology.  Even Oracle got into the consolidation game after the Bubble burst with its acquisition of PeopleSoft.  Leveraging acquisitions to accelerate entry and growth in new markets is not a new tactic and is certainly one that Cisco has used to its advantage.  Since 1993 Cisco has purchased over 136 firms and now over 50% of the company’s revenues come from acquired companies.  Historically, Cisco has paid significant premiums for the companies they acquired.  The great consolidators, on the other hand, took significant pride in how little they paid.  So when we look at Cisco’s two most recent acquisitions one has to ask does it make sense to pay three to five times the going rate for technology companies in 2009?

Let’s compare Cisco against the last standing consolidator – CA, Inc.  Aside from the scale of their revenues and the amount of cash on hand their financial metrics are remarkably similar:

cisco-3 

 

 

 

 

 

 

Almost all of the key metrics are remarkably similar – Cisco’s Price/Sales, Price/Book, and EV/EBITDA multiples are 20% to 30% higher than CA’s.  Surprisingly, Cisco’s EV/Revenue multiple is 2% less than CA’s.  Is it possible that a bottom feeder like CA could be considered, on a relative basis, as valuable as Cisco?  The answer is clearly no and there’s an important lesson for tech company CEOs and Boards of Directors in understanding the difference between a CA and a Cisco.  Take a look at the following table. 

 cisco-4

In the past five years Cisco has grown their revenues 79% from $22 billion to over $39 billion.  In the same time frame CA has grown their revenues $945 million or about 28.4%.  During this period Cisco has been able to grow their revenues at the same relative rate of profitability.  Cisco has amassed a huge pile of surplus cash ($22.6 billion), whereas CA has a net cash position of $250 million.  Cisco’s growth in revenues and cash has created massive wealth in terms of equity valuation for their shareholders.  As Sterling Williams, the CEO of the former Sterling Software used to say “Revenue solves all problems.”  Cisco understands that sustained revenue growth is the key to the long term value of their business. 

‘Paying Up’ for acquisitions is not popular and was considered to one of the most egregious since of the Internet Bubble.  Yet, as Cisco has demonstrated, paying up for the right properties is an extremely valid strategy.  As noted in their press release announcing the Pure Digital deal “The Pure Digital acquisition exemplifies Cisco’s “build, buy and partner” innovation strategy to move quickly into new markets and capture key market transitions.”

For tech companies struggling in today’s market to maintain and expand revenues it might be worthwhile to consider taking a page out of Cisco’s playbook.  Instead of trying to be a bottom feeder and only search out tech company acquisition candidates that are willing to sell at a discount, look for firms that are poised to take advantage of the tectonic shifts in today’s market that could fundamentally, and organically expand your revenues.

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4 Responses to “Did Cisco Hand Out a Few Golden Eggs for Easter?”

  1. TwoFingerPoi Says:

    Cisco acquires Tidal, leaves BMC behind

    CSCO decided to go with a smaller (cheaper), lower risk Tidal acquisition to gain automation software functionality. I think the “OEM” deal with BMC is a non-starter and dead in the water. A BMC acquisition would have been more typical of a “consolidator”.

    The “consolidators” have traditionally paid modest total prices for substantial revenue, especially maintenance, streams while the “growth innovators” snap up smaller vendors with limited revenue but technology that can create incremental or even aggressive growth opportunities. The strategies and results are obviously different.

  2. John Mecke Says:

    Thanks for the comment. I almost included Bob Beauchamp from BMC in my post. I worked directly for Sterling Williams for a number of years and got to know Charles Wang, ‘Flip’ Filikowsi, and Art Allen from ASG pretyy well. Your comments were spot on. JCM

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