August 26, 1999 1:00 PM PDT

Cisco buys Cerent, Monterey Networks

Cisco Systems today agreed to acquire privately held Cerent and Monterey Networks for a combined $7.4 billion in stock, giving the dominant maker of Internet equipment a firm footing in the exploding optical transport market.

With the acquisitions, Cisco is gearing up to battle Lucent Technologies, Alcatel, and Nortel Networks in a market that is expected to grow to $10 billion in 2002, according to analysts.

"[The optical transport market] is extremely hot," said Chandan Sarkar, an analyst at Soundview Financial. "[Cisco] clearly had a hole in the transport portion of their portfolio. This is a going to be their one big step to plug that hole."

Cisco hopes the acquisitions will help service providers quickly migrate from traditional circuit-based networks to newer technologies.

"Anyone who follows our market knows that optical transport was going to explode. This is how the industry is going to evolve," said John Chambers, Cisco's chief executive.

"This is going to be a $10 billion-plus market, and if we can execute right we can get a 20 to 25 percent market share," Chambers said today during a speech at Dell's DirectConnect conference in Austin, Texas.

Petaluma, California-based Cerent produces devices that carry data, voice, and video over fiber-optic lines. Monterey, based in Richardson, Texas, makes products that are used to increase the capacity of optical networks.

Today's acquisitions put the company in a position to compete against Lucent and Nortel, which have similar product lines. Analysts noted that Lucent and Nortel have to simply evolve some of their products to offer built-in data interfaces and cross-connect technology to boost network capacity.

"[These companies] won't have to go out and buy anyone" to compete against Cisco, said Sarkar.

Under the terms of the Cerent agreement, 100 million shares of Cisco common stock will be exchanged for all outstanding shares, options, and warrants of Cerent not currently owned by Cisco. The deal is based on Cisco's closing price yesterday of $68.625. That puts the Cerent acquisition at about $6.9 billion--Cisco's largest deal ever.

This acquisition will be accounted for as a pooling of interests and is expected to close in the first half of Cisco's fiscal year 2000.

Under the terms of the Monterey agreement, 7.3 million shares of Cisco common stock will be exchanged for all outstanding shares, options, and warrants of Monterey that Cisco does not already own. Based on Cisco's closing price yesterday, that deal is valued at about $500 million.

Cisco expects a one-time charge against after-tax earnings of between 7 cents and 11 cents per share for in-process research and development expenses in the first quarter of Cisco's fiscal year 2000.

Both acquisitions have been approved by the board of directors of each company but are subject to various closing conditions, including federal antitrust approval.

The price Cisco is shelling out for Cerent has raised some eyebrows on Wall Street, analysts said.

"Frankly, I was a little shocked at the price," said Sarkar.

Cerent lost $29.3 million on nearly $10 million in sales during the first half of 1999.

Cerent's decision to be purchased by Cisco comes just a month after the start-up filed for an initial public offering to raise as much as $100 million.

Cerent was founded in 1997 and has 287 employees. Monterey, founded in 1997, has 132 employees. Both companies will become business units within the Transport Group reporting to Kevin Kennedy, senior vice president of the Cisco's service provider business.

News.com's Michael Kanellos contributed to this report from Austin, Texas.

 

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