Ericsson: Ready to Rumble with Cisco

The Swedish outfit's pricey purchase of Redback Networks bolsters its presence in the red-hot broadband arena

Ericsson (ERIC), the Swedish telecom equipment maker that got into severe financial trouble during the telecom and dot-com bust, has made a solid comeback. But it still has some holes in its product lineup. So the company decided to buy San Jose-based Redback Networks (RBAK) for $1.9 billion in a deal announced Dec. 20. The deal is intended to make sure that Ericsson keeps pace in the fast-growing area of IP telephony. But the move will also put Ericsson into more direct competition with equipment suppliers like Cisco Systems (CSCO) and Juniper Networks (JNPR).

Redback is a leading provider of equipment and services for managing IP and broadband communications traffic. The company says it manages 50 million broadband connections for 15 of the world's top 20 telecom carriers. The deal gives Ericsson added heft in IP telephony, internet broadcasting, online gaming and video on demand where the company was thought to be somewhat weak. "The Redback acquisition is an expensive life insurance policy for Ericsson," says Falk Mueller-Veerse, of Cartagena Capital, a boutique investment bank that specializes in telecom. "Ericsson had difficulties getting on the IP train. Their very late move should help them stay a top player. "

The deal also shows, analysts say, that Ericsson, which pared itself down to a company that largely specialized in mobile telecom infrastructure in the 1990s, is now broadening out once again to supply a wide assortment of fixed line and broadband equipment and services as well as mobile gear to telecom operators worldwide. For the first nine months of 2006, Ericsson's operating income was up 4% year on year to $3.4 billion on sales of $17.9 billion.

A key area for expansion will be Internet television, says Redback CEO Kevin DeNuccio. "Video changes everything about networks today," says DeNuccio. "We have plans to build some very big high-speed routers," to handle IP TV, he ads, noting that R&D will now be stepped up thanks to Ericsson's deep pockets.

Ericsson is definitely paying a stiff price for Redback, creating worries that the Stockholm company is getting caught up in a new tech frenzy. The purchase price is a 60% premium on Redback's 90-day volume weighted average stock price and an 18% premium on its Nasdaq closing price Dec. 19. Redback shares shot higher by 20%, to $25.47 in late Nasdaq trading Dec. 20. Ericsson's American Depositary Receipts were little changed in late trading on Nasdaq Dec. 20.

Ericsson also may now have a tricky task in managing its relations with Cisco and Juniper Networks, which supply high-end telecom gear. Ericsson now resells their equipment to telcos, according to London-based Merrill Lynch (MER) analyst Sandeep Malhotra. "Ericsson would now directly compete with both companies in the highest growth segment of routing."

Redback has been growing fast after emerging from bankruptcy in 2004. Sales of $193 million for thee first three quarters of 2006 grew at an 87% year on year rate. The company posted an operating loss of $7.8 million for that period. One challenge for Ericsson will be keeping Redback's employees and merging the company into Ericsson's culture, something that has often proved difficult when Swedish companies, which offer relatively low pay, buy American companies. Redback CEO Kevin DeNuccio, who will stay on, promised "a Silicon Valley style compensation package" to keep employees.

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