Acquisitions often make investors nervous, as the temptation/risk to overpay is so high and there are reams of research indicating that most deals destroy shareholder value for the acquirer. By the same token, sometimes M&A is the only way to fill a product/technology gap and position the company for future growth. While Cisco (Nasdaq:CSCO) shareholders are certainly going to hope that the deal for Meraki advances Cisco's software-defined networking (SDN) strategy, the price tag is going to cause more than a little wincing.
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$1.2 Billion Today, for How Much Tomorrow?
Cisco announced Sunday night that it is acquiring privately-held Meraki for $1.2 billion in cash. Meraki was a hot name among private companies with its Wi-Fi products for the small/mid-sized business (SMB) market. Just as significant, however, is the ability for Meraki technology to oversee Wi-Fi access from the cloud and communicate with devices through a central server. I suspect that it is these latter parts that are the keys for Cisco, as they will fill a gap for cloud-based LAN solutions.
As a private company, Meraki has been cagey in discussing its finances. Nevertheless, analysts seem relatively sure that the company's annual revenue number is somewhere in the neighborhood of $100 million to $200 million, with most estimates at the lower end of the range. Consequently, that breaks out to a pretty hefty premium of 6 to 12 times trailing sales. Aruba Networks (Nasdaq:ARUN), arguably the best publicly-traded peer, presently trades at about 4 times trailing sales.
SEE: Analyzing An Acquisition Announcement
SDN Changing the Field
While Cisco is active in wireless networking and enterprise Wi-Fi, this deal is likely just as much about SDN for the long term. In that respect, it's another in a recent flurry of deals in this emerging space.
VMware (NYSE:VMW) paid $1.2 billion for Nicira this summer, while Oracle (Nasdaq:ORCL) picked up Xsigo, and Brocade (Nasdaq:BRCD) acquired Vyatta. This isn't even Cisco's only recent deal in the space either, after it picked up vCider in October.
Why all the fuss? SDN is about separating the software from the physical hardware in networking, and achieving a more efficient architecture in so doing (separating the "control plane" from the "data plane"). This process basically moves the "magic" out of the boxes and allows the user to go with commodity networking gear, but it also allows for faster optimization.
What Happens Now?
Aruba is also moving into SMB Wi-Fi, so while the company could benefit from disruption/transition between Cisco and Meraki, this puts Cisco further into Aruba's wheelhouse. On balance, that's a bad thing. All of that said, while I don't think this is great news for Aruba (and the stock was understandably trading down in early trading), I suspect this deal has a lot more to do with responding to companies such as VMware and Oracle and furthering Cisco's position in SDN, as opposed to crushing Aruba.
With this deal, I would think that investment bankers are going to be knocking on the doors of other private companies involved in SDN, such as Aerohive, Big Switch, Cyan and Plexxi. I would think Juniper (NYSE:JNPR) is likely feeling more pressure to respond, and companies such as Oracle, IBM (NYSE:IBM), Hewlett-Packard (NYSE:HPQ) and Dell (Nasdaq:DELL) may also find themselves in the role of buyer. I also wouldn't sleep on the possibility that Citrix (Nasdaq:CTXS), F5 (Nasdaq:FFIV) and Intel (Nasdaq:INTC) could look to buy their way further into SDN at some point in the near future. In short, SDN isn't going away, and bankers are going to look to play matchmaker.
The Bottom Line
I wrote less than a week ago that I expected Cisco to continue to be active in deals. This is an expensive one, however, and Cisco's record with big-ticket deals has been pretty mixed. I get the appeal of Meraki and I appreciate the potential, but the road between potential and execution can be treacherous.
All of that said, even if the $1.2 billion Cisco is paying goes completely up in smoke, it wouldn't trim even 50 cents off of my fair value estimate. On the other hand, if this deal can add a half-percentage point to revenue growth or free cash flow (FCF) margin down the road, it will more than pay for itself. On balance, Cisco remains a well-heeled and undervalued Big Tech stock.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.