The growing threat from software-defined networks (SDNs) caused Cisco (NASDAQ:CSCO) to splurge $475 million on a yet another Israeli start-up, Intucell, last week. The four-year old start-up develops software that enables mobile carriers to dynamically allocate network resources in a way that decreases congestion and increases quality of service, lowering the frequency of dropped calls and service disruptions. One of Intucell’s first customers, AT&T, has already deployed the technology throughout its nationwide footprint in the U.S.
At the heart of the acquisition is Cisco’s bid to add more software-oriented capabilities to its portfolio of networking products, thereby thwarting the risk of SDNs commoditizing hardware completely. In addition, we see it as an attempt to win back share in the service provider market where its lead over competitors such as Juniper Networks (NYSE:JNPR) isn’t as commanding as in the enterprise market. The increasing service provider focus was also evident in several of its recent acquisitions such as NDS, BroadHop, Cariden Technologies and ClearAccess. (see Cisco’s NDS Acquisition Taps Video Demand To Boost Network Equipment Business)
Carriers need scalable, efficient networks
With data demands burgeoning, mobile carriers in the U.S. are increasingly looking to make their networks more spectrum-efficient in order to make the best use of their limited spectrum resources without increasing CapEx spend. The proliferation of smartphones is already causing mobile data traffic to grow exponentially, and the advent of high-speed LTE networks is likely to feed appetite for mobile data consumption even further. Mobile data traffic grew 133% in 2011 and is expected to grow at a CAGR of close to 80% over the next five years, according to a recent Cisco VNI report [Global Mobile Data Traffic Forecast Update, 2011–2016, Cisco, February 14th, 2012]. Despite some lingering macroeconomic concerns, the broader transition to mobile continues to be strong and software-based networking solutions that allow service providers to manage this huge traffic efficiently are only going to increase in importance in the coming years.
Intucell’s acquisition shows that Cisco is looking to tap this market and improve its relationship with carriers by adding such valuable network management solutions to its product portfolio. AT&T’s deployment of Intucell’s technologies and the resultant 15% reduction in network congestion and improvement in call retainability is a sign of Intucell’s value within carrier networks [Self-Optimizing Network Helps Improve AT&T Network, AT&T Press Release]. Cisco hopes that the increased service provider focus helps it gain more ground in the core and edge routing segments where rivals such as Juniper and Alcatel Lucent have substantial market share.
The spate of recent acquisitions together with Cisco’s recent decision to sell its home networking Linksys division shows that the company’s restructuring initiatives are gaining ground. The networking giant has of late tried to scale back its ambitions to diversify into 30 new businesses and instead focus on those areas that add value to its core routing and switching businesses. As a result, it has restructured its operations and cut jobs in areas that are not its core focus, making the organization leaner and more efficient.
We believe the company is heading in the right direction since the move not only allows it to innovate faster, but also streamlines its businesses around its core networking products. This unit contributes almost 40% to our estimated $26.50 fair value for Cisco, with cash contributing another 20%. In line with this view, Cisco’s stock has climbed close to 35% in the past six months and is trading around 25% below our price estimate.
Disclosure: No positions