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Cisco Whets Its Appetite for Deals

By Peter Burrows Cisco Systems' acquisitions have long been fodder for revisionist thinking. During the late '90s, the company was revered for its ability to buy and absorb startups. But once the Tech Wreck began, critics argued that only a handful of the 73 deals Cisco (CSCO) did from 1993 to 2000 actually contributed meaningful earnings.

Now, once again, the chorus is warming up with calls to buy. Investors cheered when Cisco announced a few months ago that it planned to pick up its buying activity. The reason: Its core market -- selling basic networking gear to corporations -- is expected to grow at only a single-digit rate for the foreseeable future.

Sure, Cisco is expanding quickly in emerging markets such as security and Internet-based telephony. But with $19.3 billion in cash on its books, as of the end of its most recent quarter, it should put that money to work buying stakes in growing tech niches, many analysts believe. "I want to see them get back into the acquisition game, even more aggressively than they have been," says Precursor Group analyst John Freeman.

JITTER-FREE. Cisco obliged on Aug. 23 -- and look for it to continue shopping in the months ahead. It purchased P-Cube, a 118-person networking-equipment company with employees in Silicon Valley and Israel. Founded in 1999, P-Cube makes a component that carriers such as phone companies and cable-TV providers can use to do "deep packet inspection." Most of Cisco's gear looks at only bits of a packet's header -- mostly, the data's requested destination -- before zipping the digital information on its way. But P-Cube's software looks inside the "payload" to glean information on what those packets are actually doing.

That way, a carrier could tell whether a string of packets is part of a plain old e-mail that can be delivered when it's convenient or a videoconference that must be sent in real time. That's because videoconferencing -- or a Net-based phone call, or a pay-per-view movie -- requires both more bandwidth and guaranteed bandwidth if it's to be transmitted with as little "jitter" as possible. "Broadband [penetration] is growing rapidly, and the number of services being offered over the network is expanding rapidly," says Ned Hooper, Cisco's senior director of corporate development. "This will be a huge advantage for us."

Where will Hooper & Co. look next? Most likely, Cisco will focus on the so-called carrier market, as opposed to the corporate market, where it already dominates. In coming years, many jobs now handled by in-house corporate info-tech shops will be done by carriers, which will also offer more varied services to the consumer market, including online games and high-definition video. And Cisco is facing increased competition for carriers' dollars from rivals including Juniper Networks (JNPR) and China-based Huawei Technologies.

QUICK RETURNS. Cisco is hardly throwing its cash around. It has done only a handful of deals this year -- almost all for fairly established companies that were growing well and profitable, or nearly so. That's because it's concentrating on buying outfits that quickly deliver a return on investment to shareholders, rather than new technology that may or may not pay off. While he wouldn't give details, Hooper says recent acquisitions have churned out profits that far exceed the purchase price. "We are creating substantial value," says he.

Then again, Cisco isn't bottom-feeding, either. Steve Coplan, director of mergers-and-acquisition analysis at The 451 Group, figures the $200 million paid for P-Cube is four times its current annual sales. "That's a pretty hefty multiple," he says. But Cisco can well afford it. Not only does a big purchase price tend to keep the acquired outfit's employees motivated to stay on but it raises the bar if rivals follow suit.

"If Cisco pays a lot, everyone else has to wrestle with that valuation," says Coplan. "Whether a deal costs $150 million or $200 million is fairly inconsequential for Cisco. It may be a lot more painful for other companies." So much for revisionist thinking. Burrows is Computer editor in BusinessWeek's Silicon Valley bureau

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