Cisco's EMC Venture: Better Than a Buyout?

By forging a joint venture with EMC and building products with VMware, Cisco Systems (CSCO) hopes to reap many of the benefits of an acquisition of one or both—without incurring the much higher costs and risks. Cisco CEO John Chambers indicated as much during a Nov. 3 press conference heralding the deal, when he lamented the frequent failure of tech-industry tieups. About 90% of these acquisitions don't succeed, and even more partnerships founder, Chambers said. "There are very few [companies] that acquire well, and even fewer that partner well," Chambers said at Cisco's San Jose headquarters. Cisco used the event to unveil a joint venture with EMC (EMC) and a lineup of data center products in conjunction with EMC and VMware (VMW). Together, the companies will sell what they're billing as the building blocks of data centers, massive storehouses of computing power. Known as "Vblocks," the products include networking equipment from Cisco, computer storage gear from EMC, and VMware virtualization software, which is designed to boost the efficiency of servers, the computers that run Web sites and corporate networks. Vblocks will also include chips made by Intel (INTC). Cisco and EMC will form a new company called Acadia to support the new products, and Chambers said the three companies are working on at least a half-dozen additional projects. Through the joint venture and new products, Cisco, the No. 1 vendor of networking gear, is making another incursion into the market for computer systems sold by IBM (IBM), Hewlett-Packard (HPQ), and Dell (DELL). Striking an alliance with EMC and VMware could help Cisco, one of techdom's most acquisitive companies, grab a larger share of customers' computing budgets without the cost and scrutiny of buying VMware outright. "There's been wild speculation that Cisco would buy EMC or VMware," says Brent Bracelin, an analyst at Pacific Crest Securities who has "outperform" ratings on Cisco and EMC. The deal "is a substitute for a formal merger between Cisco and EMC," he says. It "will serve as a foundation for what potentially could have been accomplished through a merger, without a lot of red tape." Street: VMware Is PriceyVMware, 82% owned by EMC, remains a coveted prize for a number of tech companies. Companies use VMware's software to consolidate the number of computers in their data centers, and to more efficiently match computing power to demand. Wall Street analysts and investment bankers say VMware is expensive relative to its earnings and growth rate, however. Shares of VMware, which closed Nov. 3 up 67¢, or 1.74%, at 39.12, trade at about 41 times the company's expected 2009 earnings. VMware's third-quarter profit fell 54%. The company is expected to report that this year's sales rose less than 5%, to $1.97 billion. EMC is also unlikely to part with VMware absent a deal that also includes EMC itself, which has a market value of $33.8 billion, analysts and bankers say. "It would have to be a hell of an offer," says Eric Gebaide, a managing director at investment bank Innovation Advisors. "Cisco has probably been nosing around them," he says. But "VMware isn't going away as a company." A Threat to IBM, HP, and OracleBuying VMware would put any potential acquirer more squarely in competition with Microsoft (MSFT), which has been including free virtualization software in its own server software. Microsoft released a new version of its virtualization software in October that includes a key feature that helps it compete with VMware. Microsoft is winning more than 20% of deals for server virtualization software, general manager Zane Adam says. VMware's business also poses a threat to IBM, HP, and Oracle (ORCL), which benefit from sales of more servers. VMware's strategy "is in everybody's face," says a tech company CEO who asked to remain anonymous. "Cisco and VMware have a strong relationship because Cisco doesn't have a dog in the hunt in the data center [server business]. I don't think anyone else likes this strategy." Cisco certainly has the currency for large acquisitions. It had $35 billion in cash and short-term investments at the end of July, and in October it said it agreed to buy video conferencing company Tandberg and networking company Starent Networks (STAR). Cisco reports its fiscal first-quarter earnings Nov. 4. During the press conference with EMC Chief Executive Joseph Tucci and VMware CEO Paul Maritz, Chambers even said he wouldn't mind having a larger stake in VMware. Cisco owns 1.6% of the company. Three-Way DealRobert Lloyd, executive vice-president of worldwide operations at Cisco, says it's "entirely speculation" that Cisco has inquired about VMware's availability, and says Cisco prefers smaller acquisitions. "We like to acquire small and partner big," he says. For now, Cisco's top brass will need to be content with a three-way deal among Cisco, EMC, and VMware that may be headache enough for competitors. Cisco is betting that networks will be at the center of new innovations in the tech industry, much as technology from IBM and Microsoft was in previous decades. Virtualization and networking are central to "cloud computing," a shift toward tapping computing power remotely, via networks, rather than in-house. As industry growth has slowed, tech companies are increasingly moving into one another's territory. In March, Cisco announced a computer called the Unified Computing System that competes with products from IBM, HP, and others. IBM announced a partnership with Cisco rival Juniper Networks (JNPR) in April. And software company Oracle is attempting to close a $7.4 billion acquisition of Sun Microsystems (JAVA) amid opposition from the European Union. "We've talked about this clash of the tech titans all year," says Pacific Crest's Bracelin. "This is evidence that this battle is intensifying."