Redback-Ericsson: A Competitive Threat to Juniper and Cisco?

|
Includes: CSCO, ERIC, JNPR, RBAK
by: MGI Research
The acquisition of Redback Networks (RBAK) by LM Ericsson (NASDAQ:ERIC) has generated a stream of commentary looking to predict which company will become the next target. There is little doubt that the consolidation in the communications equipment space (both carrier and enterprise) is going to continue and will mirror a similar process that is affecting the key customers of communications gear such as major communications services providers.

In fact, almost every company in the communications equipment space with a market cap above $100Mil is a potential acquisition target. The more interesting issue is how much of a real competitive threat is the new combined ERIC/RBAK entity to Juniper Networks (NYSE:JNPR) and Cisco (NASDAQ:CSCO)? This question does not yet have a simplistic answer. Answering it involves looking at several dimensions such as customer overlap, channel leverage, as well as conflicts and possible economic synergy that the companies may realize in a merger. In this deal, Redback will get a significantly better worldwide channel to sell their wares as well as added credibility and a service channel that would otherwise be costly to duplicate. As a starting point in assessing the impact of this transaction, we looked at an economic comparison of corporate efficiency of RBAK, ERIC, CSCO, and JNPR.

We used a proprietary metric of efficiency called the MGI Index which measures the “corporate operational fitness”, i.e. analyzes how efficient is the management of each company in allocating resources to key budget areas and getting a return. We routinely calculate MGI Index benchmarks and use them to rank companies in various tech sectors and have assembled data on over 200 companies. The higher the index value, the more efficient the company is. The change in the MGI Index can also be significant as companies with modest MGI Index values that post significant increases are generally poised for growth. The results of this MGI analysis of RBAK, ERIC, CSCO and JNPR are summarized in the table below.

Looking at the data, we observe that both RBAK and ERIC are nowhere as efficient as either CSCO or JNPR, and there is significant potential for improving the efficiency of operations in soon to be merged operations. The pace of efficiency improvements at CSCO and JNPR has been slowing down while the rate of improvement at RBAK and ERIC has been speeding up. In fact, at one point Ericsson used to be right near the bottom of the 5th Quintile amongst other large technology providers, so their turnaround is rather impressive. Still, Cisco and Juniper Networks have consistently scored well in the MGI Index ranking in good times and in bad.


mgi_index_redbackericsson_jpeg_5

MGI chart

Key to MGI scores:
THE MGI Index is a benchmark of over 200 tech companies. It analyzes the operational efficiency of a company, taking into consideration how well management optimizes both revenue growth and margins (MGI= "Margin + Growth Index"). The best performing tech companies have MGI scores above 20, while the base of the scoring is 1. Consistency of MGI scores and directional trends (i.e., increasing or decreasing scores over several quarters) are also key indicators. Historically, communications equipment companies tend to place in the 2nd quintile of MGI Index ranking, with CSCO leading the pack amongst other communications hardware providers.

Bottom Line: If the newly combined ERIC-RBAK entity is able to retain its overall trajectory of improved efficiency, then it could pose a considerable challenge to both JNPR and CSCO. More often than not companies lose the efficiency edge as they go through a merger, especially a cross-border combination. Ericsson has a mixed track record when it comes to acquisitions and has done a number of dilutive transactions. It remains to be seen if Ericsson's latest purchase will make the company more efficient and more competitive.

Disclosure: Author has no position in the above-mentioned stocks.

About this article:

Expand
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here