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Cisco's Bold New TV Bet

Until three years ago, Cisco Systems (CSCO) steered clear of cutthroat markets for high-tech consumer gear. It stuck happily to its business of selling high-margin networking equipment to corporations and communications providers.

But Cisco changed tack and in 2003 began a slow, steady march into homes with the purchase of Linksys Group, a maker of routers for consumers. Cisco reckoned it could compensate for lower gross margins on consumer products by keeping operating costs low while cranking up sales. The experiment worked, so Cisco quietly began looking for more deals. In July it went from home offices to the living room by buying tiny KiSS Technology, a maker of networked DVD players (see BW Online, 08/05/05, "Cisco's Link to Your Living Room").

But those were just preludes to the Nov. 18 blockbuster $6.9 billion acquisition of Scientific-Atlanta, which along with Motorola (MOT) dominates the market for cable TV set-top boxes. "This is about owning the home," says Edmond Lewis, a general partner with RelevantC Business Group, a Chicago communications-industry consultant.

VIDEO EXPERTISE. It's a risky but worthwhile bet by a company intent on finding growth. Cisco's stock has been stuck in neutral for years because of investors' doubts about its ability to find new businesses that could sustain its cushy profits -- typically around 20% of sales (see BW Online, 08/10/05, "Cisco: Investors Still Aren't Convinced"). Cisco has announced a range of new growth initiatives of late, including emergency communications systems for first responders, small-business gear, and new wireless networks for corporate campuses.

But Scientific-Atlanta is by far the biggest and boldest move in years. Cisco aims to boost Scientific-Atlanta's growth rate to 14% to 16%, from 10% to 12%. Doing that would help Cisco hit the upper range of a target to achieve overall growth of 10% to 15% a year.

Maybe more important, the acquisition gives Cisco products and expertise in video services. That in itself could be a $10 billion market by 2009, says Cisco Chief Executive John Chambers.

BUNDLE WARS. Certainly the timing is good. For years, cable and phone companies have been pouring money into building so-called converged networks, capable of delivering all manner of digital traffic over gear based on the Internet Protocol. Now these carriers are racing to fill these networks with a profitable "quadruple play" of services that combine Internet access with Net-based phone calling, wireless calling, and video services.

While already a dominant supplier in the first three, Cisco had been a relative no-show in video. "Once you add video, not just in products but in being able to integrate them all together, that gives us leadership that is very, very unique," Chambers told analysts the day the deal was announced.

Indeed, the deal could make Cisco a far more formidable supplier to various camps in the bundle wars, which for the most part pit cable providers against telephone companies such as Verizon (VZ). In particular, it strengthens Cisco's ability to help cable companies such as Comcast (CMCSA) and the cable division of Time Warner (TWX).

MARQUEE TELECOM ACCOUNTS. Cisco already sells roughly $1 billion a year to cable companies, but this will let it sell a soup-to-nuts suite of products -- from its routers that direct Internet traffic, to Scientific-Atlanta's head-ends, which pull programming down from satellites for delivery to subscribers’ homes -- and finally its set-top boxes. Scientific-Atlanta has a nearly 50% share of the millions of homes that have set-top boxes.

While some cable executives might balk at having one supplier be that powerful, Scientific-Atlanta President Jim McDonald said he spoke with his two largest customers on Nov. 17, and both were positive. "They're interested in speed to market, and how you integrate all of this to make it work," he told analysts.

Solidifying Cisco's position with cable companies could be a huge advantage, since they have made by far the most progress in the early innings of the contest against phone companies. The cable companies currently provide video service to 70 million U.S. homes, compared with less than 1 million for the phone companies that only now are rolling out video offerings. Also, the cable companies have made far more progress selling phone and broadband access to big phone-company customers than the other way around.

But Scientific-Atlanta could help Cisco with phone companies as well. Until two years ago, the 50-year-old communications company sold only to cable companies. Since then it has landed some marquee telecom accounts. It will provide the set-top boxes in SBC's Project Lightspeed, which is supposed to bring IP-based TV services to 18 million homes by the end of 2007.

THREAT TO MICROSOFT? And Cisco may have bigger plans up its sleeve to help carriers of all stripes reach consumers. For example, analysts expect it to try to make a big splash with the networked DVD players purchased from KiSS. By integrating this technology into Scientific-Atlanta's set-top boxes, for example, Cisco would allow consumers not only to receive content via their set-top box but also make DVD copies of favorite shows and even transfer programming to other PCs or TVs in the home, depending on licensing rules imposed by owners of that content. "Having Scientific-Atlanta plus Linksys will enable carriers to bring new services to the home," says Cisco Senior Vice-President Dan Scheinman. "As you connect your set-top box to your wireless network, you'll be able to get what you want, where you want, on the device you want."

That could step on some other industry players' toes. Alcatel, for example, has landed a series of big contracts to help carriers create converged IP-based networks and fill them with new-fangled services, including SBC's IPTV plans. And many say Cisco's new push for the home puts it in increased competition with Microsoft. Indeed, the software king has made almost no progress in having any of its software deployed in set-top boxes -- in part because Scientific-Atlanta and Motorola have their own proprietary technologies.

As a result, Microsoft has focused its efforts on creating its IPTV software for the phone companies, which have minuscule market share in video and must still prove they can cut it in this industry (see BW Online, 11/15/05, "Microsoft and Cisco: Ready to Rumble?"). "Microsoft can't be happy about this," says Jeff Binder, president and founder of Broadbus Technologies, a video-on-demand technology provider. "Cisco is a much bigger threat to Microsoft with the telcos than Microsoft is to Cisco in cable."

BOLD MOVES. Indeed, many industry eyes will be watching to see what happens with San Antonio-based SBC (SBC). As of now it's using Microsoft's IPTV software, along with routers from Alcatel and Scientific-Atlanta's set-top boxes. But many in the industry claim Microsoft may be behind schedule, something the company denies. Still, "the folks in San Antonio have got to be pleased," says RelevantC's Lewis. "They now have a second potential supplier, and that gives them more pricing leverage and flexibility."

That said, Cisco faces vast challenges as well. Most obviously, the deal breaks the mold from scores of past acquisitions. Chambers stuck religiously to buying small Silicon Valley outfits with slick new Internet-style technology -- not 50-year-old proprietary-technology companies located on the other side of the country. And while Chambers and McDonald insisted there was a cultural mind meld between the two companies, that's a minority opinion.

"My father used to run Varian Associates in the 1960s, and he competed with Scientific-Atlanta," says Ron Sege, chief executive of wireless gear maker Tropos Networks. "They're very set in their ways. And Chambers has said it himself: 'Big acquisitions almost never work.' If you're mindful of history, you'd have to be concerned."

Than again, few companies have more expertise at making acquisitions work. And if Cisco's investors were waiting for some bold move to grab their attention, this one makes a lot of sense. Because history also shows that bold bets sometimes pay off.


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