Cisco Systems Inc. (CSCO)’s quest for acquisitions while grappling with its worst stretch of sales growth is making takeover candidates out of Citrix Systems Inc., NetApp Inc. and Rackspace (RAX) Hosting Inc.
Cisco, with its stock price down 41 percent since November 2007, has gone too long without a “major” acquisition and failed to invest enough in companies it purchased, Chief Executive Officer John Chambers said Dec. 7. Four months earlier, he bought NDS Group Ltd. for about $5 billion, Cisco’s third-largest deal, according to data compiled by Bloomberg.
As the network-equipment industry matures, Chambers is contending with two straight years of sales rising less than 8 percent and analysts estimating three more years below that level, an unprecedented streak, data compiled by Bloomberg show. Citrix and its technology for delivering services over the Internet may appeal to Cisco, Thrivent Financial for Lutherans said. Data-storage company NetApp is another candidate, according to Thrivent, while JMP Securities LLC says Rackspace’s website-hosting business may prove alluring.
“They recognize that in order to grow, they’ve got to expand,” Erik Suppiger, a San Francisco-based analyst at JMP Securities, said in a telephone interview. “It’s about Cisco trying to identify market opportunities and going in some different directions. That’s what I think is the urgency.”
Karen Tillman, a spokeswoman for San Jose, California-based Cisco, declined to comment on the company’s takeover plans. Today, shares of Cisco rose 1.3 percent to $20.11, the highest closing level in seven months.
While Cisco is the largest maker of routers and switches used in computer networking, competition with Juniper Networks Inc. (JNPR) and Huawei Technologies Co. has increased, forcing Chambers to seek growth in other areas. The 28-year-old company has used acquisitions to expand into new areas, including the 1993 deal for Crescendo Communications that got Cisco into network switching. That business generated 32 percent of Cisco’s fiscal 2012 revenue, making it the company’s biggest division.
Cisco has announced $6.79 billion of takeovers in 2012, its busiest year since 2000, topping the $6.39 billion of takeovers revealed in 2005 and $6.22 billion in 2009, according to data compiled by Bloomberg.
The company agreed to purchase NDS for about $5 billion in March, adding software used in next-generation video services. NDS, which makes software for pay-TV channels, was co-owned by Rupert Murdoch’s News Corp. and London private-equity firm Permira Advisers LLP. The transaction closed in July.
The purchase of NDS was the biggest for Cisco since 2006, when it completed the acquisition of Scientific-Atlanta Inc., a maker of television set-top boxes, for $5.2 billion. Still, Chambers said during a Dec. 7 conference with analysts that he’s gone too long without a “major” deal, citing the $2.2 billion purchase of Starent Networks Corp. in 2009 and the $3 billion deal for Tandberg ASA in 2010 as examples. Starent made equipment used by wireless carriers to deliver multimedia content, while Tandberg made videoconferencing systems.
“You will see us more active in the M&A side of the house,” Chambers said. “We’d done some very important strategic smaller ones, but no major ones. And that cost us at least 1 percent on revenue.”
Cisco’s sales rose 7.9 percent in fiscal 2011 and 6.6 percent in fiscal 2012, which ended in July. Analysts project annual revenue growth ranging between 5.6 percent and 6.3 percent through 2015, according to the average of analysts’ estimates compiled by Bloomberg. Growth has never stayed below 8 percent for so long, the data show.
“Here’s a company that’s pretty sizable, and you need to give more products and more capabilities to your salespeople to sell,” William Choi, a New York-based analyst at Janney Montgomery Scott LLC, said in a phone interview. “New opportunities are going to take several years of R&D.”
Chambers, the CEO since 1995, has stated he wants Cisco to become the top information-technology company. To do so, he has identified software and services as key areas for Cisco to expand. International Business Machines Corp. embraced a similar strategy when its hardware business dwindled. IBM is now the largest computer-services provider.
A major acquisition could cost $10 billion or more, according to JMP’s Suppiger. Both Citrix (CTXS) and NetApp have market values of about $12 billion. Rackspace trades for $9.4 billion. Chambers, during the Dec. 7 event, said $20 billion was too big. Cisco’s market capitalization is $107 billion.
Citrix is a possibility, said Thrivent Financial’s Peter Karazeris. Buying the Fort Lauderdale, Florida-based company would give Cisco virtualization software and other technologies for delivering so-called cloud services over the Internet. Cisco and Citrix already have a relationship and announced a “significant expansion” of that partnership in October.
“There’s a lot of things that Citrix is participating in that Cisco has talked about,” Karazeris, a Minneapolis-based analyst at Thrivent, which oversees $76 billion in assets and owns shares of Cisco and Citrix, said in a phone interview. “Citrix is a software company, it fills that hole. Software tends to be higher margin. That’s accretive to Cisco’s gross margin.”
Citrix will increase revenue between 13 percent and 16 percent each year in 2012 through 2016, according to analyst estimates compiled by Bloomberg. The company’s shares rose on Dec. 7 following Chambers’ comments about takeovers, climbing 3.3 percent.
Laura Heisman, a spokeswoman for Citrix, didn’t return a message seeking comment on Cisco. Citrix shares added 1.8 percent today to $66.18, the highest close in two months.
NetApp (NTAP), which would give Cisco data-storage hardware and software to flesh out Cisco’s existing offerings in servers and networking gear, is another candidate, Karazeris said. Last month, its enterprise value sank to 5.7 times earnings before interest, taxes, depreciation and amortization, the cheapest level since 2008. The valuation for the Sunnyvale, California- based company is now 8.2 times.
While NetApp’s revenue grew 22 percent in fiscal 2012, increases will be between 1 percent and 8.7 percent annually through 2017, analysts’ estimates compiled by Bloomberg show.
“Financially, it’s a good transaction,” Karazeris said. “Strategically, it’s not crazy. It does fit.”
Thrivent owns NetApp shares.
Jodi Baumann, a spokeswoman for NetApp, didn’t return an e- mail or voice mail seeking comment. Today, NetApp rose 0.6 percent to $33.18, ending a three-day losing streak.
Rackspace, a San Antonio-based company that hosts websites, could be another candidate because it would give Cisco widely used data-center technologies, JMP’s Suppiger said. Analysts see sales growth averaging 22 percent between 2012 and 2016, data compiled by Bloomberg show.
Rachel Romoff, a spokeswoman for Rackspace, declined to comment. Rackspace shares slipped 0.3 percent to $68.55 today.
Other possible targets include Linthicum, Maryland-based Ciena Corp. (CIEN), which makes switches, and Sunnyvale, California- based Infinera Corp. (INFN), which sells semiconductor chips and equipment for optical networks, according to Alexander Henderson, a New York-based analyst at Needham & Co.
Representatives at Ciena and Infinera didn’t return e-mails or voice mails seeking comment. Ciena shares fell 2.6 percent while Infinera rose 0.7 percent today.
Cisco’s history of deals isn’t without blemishes. It spent $590 million in 2009 buying Pure Digital Technologies Inc., the seller of Flip video recorders, only to stop making the devices after they were supplanted by smartphones.
Cisco has hired Barclays Plc to find a buyer for Linksys, which makes routers for home wireless access, said people with knowledge of the matter. Linksys is likely to fetch much less than the $500 million Cisco paid for it in 2003 because it is a mature consumer business with low margins, according to the people, who asked not to be identified because the process isn’t public.
“Their track record is spotty,” Needham’s Henderson said in a phone interview.
With $45 billion in cash and equivalents, Cisco is poised to do a deal, Karazeris said.
“We know they’re going to be spending their cash,” he said. “It’s not so much buying for growth. I think that’s what led them down the wrong path before. It’s making strategic acquisitions that will increase margins. What a shareholder is going to care most about is doing an acquisition that will create good returns.”