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Shares of Extreme Networks (NASDAQ:EXTR) rose a full 7% in Thursday's trading session after the provider of local area network (LAN) switching solutions announced the acquisition of Enterasys, which will more than double its operations.

As the company has not given very many financial details regarding the deal, I remain on the sidelines. I will re-evaluate the prospects at the first-quarter earnings report, awaiting more information.

The Deal

Extreme Networks announced that it has reached an agreement to acquire Enterasys. Extreme will pay $180 million in cash for the company.

Enterasys focuses on wired and wireless network infrastructure, as well as security and management solutions. Enterasys has large clients including ING and Comcast, and following a two-year integration effort, operations will be merged with Extreme Networks.

The 933 employees of Enterasys will be added to Extreme Networks creating a company with almost 1,700 employees.

The acquisition brings strong wireless LAN, network management and security technologies. Combined with increased research and development efforts it will accelerate the future ambitions of the combined company. CEO Chuck Berger commented on the deal:

Our number one priority in combining these companies is to ensure an even more positive customer experience, preserving the value of their current investment, avoiding any disruption and delivering products and technologies that combine the best of both companies.

Enterasys generated trailing revenues of around $340 million over the past 12 months. As such the deal values the company at little over 0.5 times annual revenues.

Extreme Networks will finance the purchase with $105 million in cash and $75 million from a new credit line. The deal will be accretive to non-GAAP earnings in 2014, and will result in positive cash flows from operations.

The deal is subject to normal closing conditions and it is expected to close in the fourth quarter of this year. The boards of both companies have already agreed to the deal.

Valuation

Extreme Networks ended the year ending on June of this year with $205.6 million in cash, equivalents and marketable securities. The company operates without the assumption of debt, for a solid net cash position.

Revenues for the past year came in at $299.3 million, down 7.2% on the year before. Net income fell by almost 40% to $9.7 million.

Factoring in gains of 7%, with shares trading at $4.30, the market values Extreme Networks at $410 million. On a stand-alone basis, operating assets were valued at $200 million. This values the company at around 0.7 times annual revenue and 20 times last year's earnings.

Extreme Networks does not pay a dividend at the moment.

Some Historical Perspective

After spiking around $125 during the 2000 Internet bubble, shares of Extreme Networks have seen a long-term demise. Shares gradually lost ground as they hit upon lows of just above $1 in 2009.

From that point in time shares have seen a gradual recovery, trading mostly between $3 and $4 in recent years, now breaking out upwards on the news of the deal.

Between 2010 and 2013, revenues stagnated around the $300 million level. The company roughly broke even in 2010 and 2011, followed by modest profits in 2012 and 2013.

Investment Thesis

Extreme Networks seems to have made a lot of progress this year, including a transformational deal, the hiring of new executives and strategic deals.

Following the deal, Extreme Networks will generate $630 million in annual revenues. The solid net cash position of $205 million would be reduced to $25 million following the deal. Based on that, operating assets of the firm will be valued around $385 million, or 0.6 times annual revenues.

Net earnings should accrue a sizable amount over the $10 million reported for the last year. Unfortunately the company did not report about the current profitability of the company and expected synergies. The deal seems to make strategic sense, as both companies complement each other in their operations, which should result in potential for synergies. The integration of both companies should take place within two years creating a high performance combination for open solutions for wireless LAN, mobility, and data centers.

Earlier the company already made deals with giants like Lenovo and EMC (NYSE:EMC). Lenovo, which is the largest PC vendor, wants to become a force in the server market as well, having selected Extreme Networks to be its networking partner. The company received its EMC versification as well, being only one out of three networking vendors receiving this license.

The company furthermore changed CEOs and made Chuck Berger the chief executive of the business earlier this year. Besides hiring Berger, the company announced the hiring of Ed Carney, a veteran who previously worked with IBM and Cisco Systems, to manage product development.

So there are a lot of exiting things happening with an income CEO, the deal and large partnerships. Combined with a flattening structure of the marketing organization, revenue growth should be reignited going forward. Most likely, the $75 million share repurchase plan, under which $60 million is still authorized, will be put on hold given the deal, which will take a large chunk out of the company's cash balances.

So I must conclude all these developments are really exciting. Yet I would like to see a bit more information, especially surrounding profitability and expected synergies following the deal. I will again take a look at the prospects at the next quarterly earnings report, looking for clues whether this transformational deal can result in significant value creation.

Source: Extreme Networks - Extremely Good Enterasys Deal?