March 20, 2003 11:02 AM PST

Cisco heads home with Linksys buy

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Networking giant Cisco Systems on Wednesday said it would buy Linksys, a manufacturer of networking gear for consumers, in a stock deal valued at $500 million.

The deal will facilitate Cisco's entry into the consumer networking market, the company said in a statement. Following the close of the acquisition, Cisco will operate Linksys as a division and will continue to sell its products under the Linksys brand name.

"This acquisition supports our vision to drive innovations into the consumer market and create next-generation home networking solutions," Charles Giancarlo, senior vice president and general manager for product development at Cisco, said in a statement.

Linksys manufactures about 70 wired and wireless products for homes and small offices, selling them mainly at retail. The Irvine, Calif., company has about 300 employees.

Cisco will issue common stock worth about $500 million to acquire Linksys, and it expects the deal to close in the fourth quarter of its fiscal year 2003, which ends in July. Cisco also expects charges for the acquisition to subtract no more than 1 cent per share from its fiscal 2004 profit. After charges, the company said it would add about 1 cent to 2004 earnings per share.

The acquisition has been approved by the board of directors of each company, but will be subject to closing conditions, including a waiting period, under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, Cisco said.

While the acquisition isn't expected to add significantly to the networking giant's revenue, it will give Cisco a solid position in one of the few bright spots in the market. Linksys is one of the market share leaders in home networking gear with a 39 percent share of the consumer, small-office and home-office retail market in North America.

"Home networking growth is being driven by the wide spread growth of residential broadband access which is projected to increase worldwide by 35 percent annually," Giancarlo said in a conference call.

Linksys will have access to Cisco's sales channels to address international markets, something it is just starting to do as it looks to increase its revenue. As a result of the acquisition, Cisco will broaden its reach into the consumer market and Linksys will broaden its reach into the international market, Giancarlo added.

"Home networking is the only part of the networking market that is growing quickly," said William Bao Bean, an equity research analyst with Deutsche Bank Securities. "Getting into this market is table stakes for any players that want to cash in on the trend towards convergence of broadband voice, data, video and multimedia."

Home networks allow consumers and small offices to share resources, such as high-speed Internet access and printers, as well as content, such as digital music, photos and gaming, over wired or wireless local area networks.

Going after consumers is a departure from Cisco's traditional business audience, which may explain why the company is going to take a hands-off role in the running of Linksys.

Bean said Cisco sees the small-office and home-office networking market as a $3.7 billion industry that is growing.

Linksys CEO Victor Tsai said in an interview with CNET News.com in late January that despite the entry of big names, such as Microsoft and Sony, into the home networking market, Linksys could survive as a standalone company, but as the market matured there would be consolidation.

Bean expects two players to drop out of the home networking market this year, following two from last year.

Hooked on Wi-Fi
Cisco is looking to be more of an active player in the development of the wireless networking market, which Linksys--through its access points and PC Cards--has a significant role in. In late February, Cisco announced it would license software designed to improve the security and range of wireless networks that use Wi-Fi technology to help drive the use of wireless networks within corporations. Businesses have been slow to adopt the new technology out of security concerns.

Consumers, however, have not been gun-shy on wireless networking, and the market may be may be maturing faster than many expected, as shipments of Wi-Fi gear triple and average selling prices drop quickly.

The Linksys acquisition may add another wrinkle to Cisco's relationship with Dell Computer. The PC maker sells a wide range of Linksys networking gear, alongside its own line of Dell TrueMobile wireless networking cards and base stations.

Cisco dropped a partnership with Dell, which sold Cisco networking equipment, and later called Dell a competitor. Cisco made that move about a year after Dell entered the network switch market with its own line of PowerConnect switches.

The acquisition is Cisco's third so far this year. The company, based in San Jose, Calif., went on an acquisition tear in the late 1990s as the Internet boomed. It bought 18 companies in 1999, and 23 in 2000, according to its Web site. But challenged by economic and networking market slowdowns, it purchased just three companies in 2001 and five companies last year.

Investment bank Merrill Lynch said in a research note that the deal was a net negative, citing margin pressure, a poor track record in the consumer market, no synergies between distribution channels and the perception that the acquisition signals further weakness in Cisco's core enterprise networking business. However, given Linksys' relative size compared to Cisco the impact should be small.

On Wednesday, Cisco announced it would buy SignalWorks, a Mountain View, Calif., developer of software for Internet telephony, in a stock deal worth $13.5 million.

 

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