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Summary

  • Cisco Systems acquires Tail-f Systems, a provider of traditional and virtualized network solutions.
  • The company is facing gaps in its product and service offerings, something which it tries to solve by making nimble acquisitions.
  • Fair valuation, strong balance sheet and high shareholder payouts lower the risks.

On Tuesday, Cisco Systems (NASDAQ:CSCO) announced the acquisition of Tail-f Systems, a small Swedish provider of traditional and virtualized network solutions.

The deal is very small but shows Cisco's commitment to acquire knowledge and services to solve weak spots in the company's product and service line. I remain cautiously optimistic about the prospects amidst a fair valuation, a strong balance sheet and steep shareholder payouts.

Deal Highlights

Cisco announced that it intents to acquire Tail-f Systems, a privately held company. The company provides solutions for both traditional and virtualized networks.

The Swedish-based company helps service providers and corporate IT teams to implement applications, network services and solutions in a cost-effective manner.

Cisco will pay $175 million in cash and retention-based incentives for the company with Tail-f joining Cisco's Cloud and Virtualization Group. The deal is expected to close in the fourth quarter of this year.

Strategic Rationale

Increased network traffic and sprawling infrastructure makes managing service provider networks an ever more complex and expensive task.

Tail-f accelerates Cisco's virtualization strategy to deliver software which increases value to customers, being supportive to Cisco's long term commitment to open standards, architectures and multi-vendors.

All of these developments are driven by the ¨Internet of Things¨ which require new services and capabilities from service providers. Cisco is facing stiff competition from various new competitors in this area.

An article on lightreading.com sheds some light on the size of the deal. It is estimated that Tail-f employs 75 in staff which generate revenues of about $30 million.

List Of Recent Acquisitions

The deal marks just the second deal made by Cisco this year after acquiring ThreatGRID in May of this year. This follows numerous acquisitions which Cisco made last year. Two of the most prominent acquisition of last year were the deals of WHIPTAIL and Sourcefire.

Cisco bought WHIPTAIL for $415 million in October in order to built upon scalable solid state memory processes to simplify physical and virtual data center environments, strengthening the company's cloud offerings.

Earlier that summer, Cisco acquired Sourcefire to boost its intelligent security solutions in a rather sizable $2.7 billion deal.

Valuing Cisco Systems

Back in May, Cisco released its third quarter results for its fiscal year of 2014. The company ended the year with $50.5 billion in cash, equivalents and short term investments, providing the company with plenty of fire power to do deals. Total debt of $20.9 billion, results in a comfortable net cash position of almost $30 billion.

The company is on track to report annual revenues of about $47 billion on which it could earn $7 billion on a GAAP basis.

Trading at $24.50 per share, Cisco is valued at roughly $126 billion which values operating assets at $96 billion. This values operating assets of the firm at roughly 2 times annual revenues and 13-14 times annual GAAP earnings.

The company is becoming a real dividend champion, currently paying a quarterly dividend of $0.19 per share, providing investors with a 3.1% dividend yield.

Slower Growth Compensated Through Increased Shareholder Payouts

Despite the numerous smaller deals in recent years, Cisco has seen problems to grow its revenues.

Instead, it has resorted to return parts of its massive war chest to shareholders. On top of the high dividend yield, Cisco has repurchased $2 billion of its shares over the past quarter, with cash being returned at a rate of over 6% per annum.

Even after the recent share repurchases, the board still has $10 billion worth of repurchases being authorized at the moment.

Bigger Restructuring Is Desired

CEO John Chambers has been leading Cisco since 1995 as he already announced plans to retire in the fall of 2012. At the time he outlined a two to four year time frame in which he would leave the firm.

With Chambers turning 65 in August of this year, it might be time for him to call it a day. Long term investors have seen incredible returns under the helmet of Chambers, with shares trading at just $2 in 1995. However over the past decade, shares have seen no returns except for the dividends which have been initiated in 2011.

Recently reports have been surfacing again, speculating on Chambers retirement which might be accompanied by a large reorganization later this year.

Takeaway For Investors

The latest deal is small and of course will not move the needle. The reported deal is just a rounding error in relation to Cisco's own market capitalization.

The problem remains the real stagnation in terms of revenues in recent years and actually declining earnings. Cisco has offset some of this stagnation by retiring shares at a rapid pace and paying attractive dividends, which has pushed shares up a little. Yet investors are starving for real operational growth again.

Back in May I checked out the company's prospects following the release of its third quarter results. I concluded that investors are growing impatient with Chambers after the company has cut its long term growth target to 3-6% late in 2013. Structural weakness and a move to the cloud hit Cisco's legacy products hard, as companies can avoid spending on ¨premium¨ equipment provided by Cisco.

Trends like cloud computing and software-defined networking allow companies to avoid using Cisco's cash cows which are routers and switches. This is exactly the reason why Cisco is snapping up companies like today's acquisition, filling the gaps in its product and service offerings.

Despite these shortcomings, Cisco operates with a strong financial position, a fair valuation and it returns cash at a rapid rate to investors. If the company can only show little revenue growth again, the perception might change altogether like it has with Hewlett-Packard (NYSE:HPQ) or Intel (NASDAQ:INTC) recently.

Until then, I remain on the sidelines although I am cautiously optimistic.

Source: Cisco Systems - Another Small Deal Shows Cisco's Commitment To Turn The Ship