Cisco (NASDAQ:CSCO) recently announced that it has completed the acquisition of UK-based small cell vendor Ubiquisys - a move that demonstrates the networking giant’s growing focus on wireless carriers and software-based networking technologies. The deal, which cost Cisco about $310 million in cash and other incentives, gives it access to Ubiquisys’ industry-leading small cell and self-optimizing network (NYSE:SON) technologies that will help Cisco strengthen its product portfolio for mobile carriers.
While small cell technology assists wireless carriers in fighting network congestion by offloading mobile data traffic onto a wired backhaul, a self-optimizing network enhances network capacity by dynamically allocating resources according to real-time changing demands. Both of these new technologies have grown in importance in recent years due to the burgeoning demand for mobile data, which has put increased pressure on carriers’ existing network infrastructure and limited spectrum resources.
At the heart of this acquisition is Cisco’s bid to add more software-oriented service capabilities to its portfolio of networking products and thwart the risk of SDNs (Software-Defined Networks) commoditizing hardware completely. Increasing focus on software and services will also help diversify Cisco’s revenue streams towards sources of a more recurring nature and mitigate the risks associated with macroeconomic uncertainty on hardware sales. In addition, we see Cisco attempting 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. Cisco’s focus on wireless carriers has been increasing of late as evident by several of its recent acquisitions such as Intucell, BroadHop, Cognitive Security, Cariden and ClearAccess which were made over the past year (see Cisco Focuses On Service Providers And Software With Intucell Acquisition).
Carriers Need Scalable, Efficient Networks
With burgeoning data demand, mobile carriers in the U.S. are increasingly looking to make their networks more spectrum-efficient and put their limited network resources to the best use without having to increase 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 the appetite for mobile data consumption even further. Mobile data traffic grew 70% in 2012, and is expected to grow at a CAGR of about 65% over the next five years, according to a recent Cisco VNI report.  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.
The recent acquisitions of Intucell and Ubiquisys show that Cisco is looking to tap this market and improve its relationship with carriers by adding valuable network management solutions to its product portfolio. AT&T’s (NYSE:T) deployment of Intucell’s SON technology and Japan-based Softbank’s use of Ubiquisys’ small cell technology in its network equipment show the increasing value of software management solutions within carrier networks. AT&T has said that using SON has resulted in a 15% reduction in network congestion and improvement in call retainability across markets.  By acquiring these companies, Cisco is hoping that the increased service provider focus will help it gain more ground in the core and edge routing segments, where rivals Juniper and Alcatel Lucent have substantial market shares.
Restructuring Has Returned Cisco’s Focus
The spate of recent acquisitions together with Cisco’s recent decision to sell its home networking Linksys division shows that the company is focusing more on the software side of networks than the hardware, which is increasingly getting commoditized. It is also a good sign that the recent restructuring initiatives have helped it regain focus on its core networking areas as against its earlier ambitions of diversifying into 30 new businesses. The restructuring may have led to job cuts in areas that are not Cisco’s core focus, but has also improved margins and made the organization leaner and more efficient as a result.
We believe the company is heading in the right direction since the restructuring not only allows it to innovate faster and actively take part in M&A deals that help it target new trends, but also streamline its businesses around its core networking products that contribute more than 40% to our estimated $27 fair value for Cisco. The long term trends of data demand, driven by the proliferation of mobile devices, as well as cloud computing’s growing usage in the enterprise, remain strong and should increase demand for Cisco’s networking gear as spending climate recovers. In line with this view, Cisco’s stock has climbed over 20% since the start of the year, and is trading around 15% below our price estimate.
Disclosure: No positions.