Cisco's Cash Position Is Safe Despite Expensive Acquisition

| About: Cisco Systems, (CSCO)

Despite the fact that the S&P 500 successfully passed the 1,400 level for the first time in four years, shares of Cisco (NASDAQ:CSCO) fell 1.4% ending the day below $20 a share. This comes after the technology giant announced the $5 billion acquisition of the privately held NDS Group.

NDS Group
Cisco will acquire NDS Group, the British provider of software and services which focuses on pay-TV operations, for $5 billion, which includes the assumption of $1 billion in debt. The acquisition highlights the focus of Cisco Systems on video. Chief Executive Officer John Chambers said the move highlights that "devices and online traffic are changing the video entertainment landscape as we know it." The acquisitions furthermore supports the strategic move away from hardware into software and cloud-based revenue sources.

Good news for New Corp
Private equity firm Permira and News Corp (NASDAQ:NWSA) acquired NDS Group for $63 a share for a total consideration of $3.6 billion as recent as February 2009. Both parties hold approximately half of the shares and stand to make approximately $700 million in profit each after selling the company for $5 billion to Cisco.

Analysts point out that Cisco made an aggressive move and the acquisition does not come cheap. However the size of NDS Group is of sufficient scale to base Cisco's video strategy on. Both boards have approved the transaction and the deal is expected to be closed in the second half of 2012.

Valuation
Cisco, once one of the most promising internet darlings has seen its business stabilize over the last years. The company has transformed from a fast growing business into a slower growing tech giant with stable margins and predictable cash flows. This caters a whole different group of investors and shares have only returned 20% over the last decade, in line with the SP500. Fat profit margins and a relatively modest dividend payout have resulted in a swollen cash position, standing at roughly $47 billion according to the latest quarterly report.

Subtracting the cash balance from Cisco's $107 billion market value implies a valuation of roughly $60 billion for the operating assets, or 10 times 2011's earnings.

Investment thesis
Shareholders are afraid that this relatively small acquisition might indicate that Cisco will squander its cash balances in future acquisitions. Shares fall 1.4% in a positive market, resulting in a market value loss of $1.5 billion. This loss corresponds to the profit that the sellers, News Corp and Permira, are making on the deal.

Although the addition might be a little expensive, it makes absolute strategic sense and strengthens Cisco for the future, so it can continue to report stable cash flows.
Valued at 10 times operating earnings and the fact that shares have lagged the market for a long time, makes this an opportunity for long term investors to pick up some shares while they are cheap.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.