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.

Forex Broker Guide: Using the right broker is essential when competing in today's forex marketplace.

$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.

Related Articles
  1. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  2. Stock Analysis

    What Will HP's Split Do to Its Stock?

    Read about Hewlett-Packard Enterprises, a new spinoff company from Hewlett-Packard. Understand how the two companies will focus on different markets.
  3. Investing Basics

    Learn How to Trade Semiconductor Stocks in 4 Steps

    The enormously diverse semiconductor industry requires market players looking for exposure have specialized knowledge.
  4. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  5. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  6. Investing News

    Why the Philippines Is the #1 Source for Tech Startups & Talent

    In the last few years, the Philippines has been working diligently to re-invent itself, and that work has paid off. The Southeast Asian nation is rapidly gaining notoriety as a leading source ...
  7. Investing News

    Austin Set to Rival Silicon Valley

    Over the years, Austin, Texas has lovingly embraced its quirky reputation with the slogan “Keep Austin Weird.” Today, the capital city is attracting several tech startups and investors, making ...
  8. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  9. Stock Analysis

    The Biggest Risks of Investing in Amazon Stock

    Find out which risks are most important to Amazon's shareholders. Learn which operational risks impact share prices and which financial risks affect investors.
  10. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!