Cisco Targets Home Run with $500M Linksys Buy

In a move likely to raise the hopes of high-tech deal watchers, Cisco Systems has entered the home networking fray by agreeing to acquire The Linksys Group, a leader in home, small-office and home-office (SOHO) networking gear, for US$500 million in stock.

“The leading position of Linksys offers a tremendous top-line growth opportunity,” Charles Giancarlo, senior vice president and general manager of product development at Cisco, told the E-Commerce Times. The home networking gear market is projected to grow from $3.7 billion in 2002 to $7.5 billion in 2006, according to the Dell’Oro Group.

Cisco has been contemplating entering the home networking market for a while. “When we first started looking into this opportunity, we were thinking this was something we would develop in-house,” Giancarlo said. “We went to many companies to attempt to learn the business. We felt we could do this on our own, but we thought it would take two to three years to build it up and a lot of investment on the front end. [The acquisition] was a way to jumpstart our entry.”

According to Giancarlo, Cisco’s entry into the home networking market will dovetail with accelerated demand for residential broadband services. By working with its service provider partners, Cisco hopes to provide new broadband applications for home users that will increase the need for different types of home networking equipment, he said.

Ripple Effects

“This deal is intrinsically significant for Cisco and the networking industry,” Ron Westfall, principal analyst at Current Analysis, told the E-Commerce Times. “This is a signal that acquisition activity is reviving.”

The deal also has significant ramifications for Cisco’s relationship with service providers, a market it has targeted for years but has had a tough time cracking. “This is Cisco’s proof point that they are indeed listening to carrier audiences,” Westfall said.

By entering the home networking market, Cisco hopes to bolster carriers’ ability to go beyond “best effort” Internet access services, he added. “Increasing the intelligence of the home network puts carriers in a position to offer higher-value, higher-margin services such as broadcast video, content on demand and gaming applications. It also gives them a wider opportunity to up-sell.”

Broad Portfolio

ThepPrivately held Linksys Group sells more than 70 home networking products, including wireless routers and access points for simultaneous sharing of broadband Internet connections, wireless network adapters and wireless print servers.

Linksys also sells wired products, such as Ethernet routers and cable modems, unmanaged switches and hubs, print servers and network-attached storage for sharing of digital music, photos and video files.

The company holds a 39 percent share of the retail consumer and SOHO networking gear market in the United States, Giancarlo said. It also commands a 57 percent share in the market for wireless networking bridges, routers and gateways.

Plans and Products

Cisco plans to runs Linksys using a “squeezed down” operating model and to sustain the company’s 30 percent gross margins. “This is a marketplace with very sensitive pricing,” Giancarlo noted.

Linksys’ latest products include a dual-band WiFi card that supports not only the prevailing 802.11b standard, but also the newer 802.11a, which offers greater range, and 802.11g standards.

On the horizon is Media Navigator, a media adapter device that allows consumer-electronics gadgets to connect to a network and access files on a PC. Linksys and Intel demonstrated Media Navigator in February. Linksys had planned to sell the device in early to mid-May for less than $200.

One product area in which the merger could create confusion is broadband DSL routers, Westfall said. “Granted, Linksys has strong branding recognition, but Cisco is still going to have to elaborate how they’re going to reconcile product overlap in business DSL routers,” he said. “It will be interesting to see what the resolution will be where the product lines clash.”

Looking Ahead

The acquisition of Irvine, California-based Linksys is expected to close in the fourth quarter of Cisco’s fiscal year 2003. Cisco expects the acquisition of Linksys will be dilutive by no more than a penny per share to its fiscal year 2004 GAAP (generally accepted accounting principles) earnings.

The LinkSys acquisition has been approved by the board of directors of each company and is subject to various closing conditions. Upon closing of the acquisition, Linksys’ business will be operated as a division of Cisco, and its products will continue to be sold under the Linksys brand through existing retail, distributor and e-commerce channels.

The acquisition is Cisco’s second in two days. On Wednesday, it agreed to buy SignalWorks, a software company specializing in IP phone technology, for $13.5 million in stock.

Under terms of the latest agreement, Cisco will issue common stock with an aggregate value of about $500 million to acquire Linksys and to assume all outstanding employee stock options. Linksys booked $429 million in revenue in 2002, a 24 percent increase from the previous year.