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Cisco Systems Inc
International Business Machines Corp
Mario Mazzola may have the best gig in Silicon Valley. Other innovators pursue their dreams at the risk of failure; there are few safety nets for an entrepreneur. But Mazzola, who builds computer networking products, is the main beneficiary of a controversial model known as the spin-in. Not once, not twice, but three times, Cisco Systems (CSCO) has agreed to fund and buy companies founded by Mazzola and his longtime lieutenants, Prem Jain and Luca Cafiero, when the startups were little more than ideas. In each case, Cisco invested $50 million or more for a stake in the company, along with an option to buy the remaining shares at a certain date. The final price, while tied to how well the startup’s products sell, is generous. Cisco paid $750 million for Mazzola’s Andiamo Systems in 2004 and $678 million for Nuova Systems in 2009. On April 19, Cisco said it was prepared to spend as much as $750 million for the trio’s most recent effort, called Insieme.
Cisco Chief Executive Officer John Chambers insists the deals are good for his company. By all accounts, Mazzola, 65, and his colleagues are one of the great product teams in the enterprise technology world. They invented a corporate networking switch—which helps shuttle data from one place to another—while at Crescendo Communications in the early 1990s. Cisco bought the company in 1993 for $94 million and built it into a $13 billion business, its largest. The funding of Andiamo in 2002 helped Cisco expand into the storage-related switch market. Nuova enabled Cisco’s most daring strategic move in decades: taking on former partners Hewlett-Packard (HPQ) and IBM (IBM) with its own line of computer servers, part of an effort to offer a full range of data-center hardware and services.
The spin-in structure lets Cisco ensure the allegiance of Mazzola and his team, rather than risk competing with them or losing them to a rival. Mazzola’s startups also help Cisco tap top engineering talent that might otherwise avoid working for a large public company. With almost $47 billion in cash, Cisco can afford its spin-in strategy—which provides huge returns if Mazzola’s team hits a home run. (With Nuova, Cisco says it earned back its investment several times over.) “The team at Insieme is a team that’s been remarkably successful for us,” Chambers told reporters on April 19.
Many former Cisco managers criticize spin-ins as destructive deals that tear at the morale of employees not lucky enough to be involved. Chambers could have made an arrangement with Mazzola, who had already earned millions as a top Cisco executive, that wasn’t so enriching to just a few people. “I think these deals basically suck,” says Samuel Wilson, a former equity analyst who now runs an investment firm called Taos Global Investors. “It suggests Cisco is willing to bribe people who are already employees and raises the question of whether these people are loyal to Cisco or to themselves.” Last fall the trio resigned just weeks after getting the final payout on the Nuova deal, then started work on Insieme.
Cisco doesn’t disclose how much Mazzola, Jain, and Cafiero earn on the spin-ins. After considering Cisco’s stake and shares given to recruits, it’s likely less than 30 percent of the purchase price, say two former Cisco managers who declined to be named because the deals are not public. Still, that could easily mean hundreds of millions for the three executives—none of which shows up as compensation in Cisco’s financial statements.
So far, no other tech companies are following Cisco’s lead. “I can’t think of any other examples,” says Harvard Business School professor David Yoffie. He suggests that other companies may worry that spin-in employees won’t work as hard as independent entrepreneurs because they lack the “unknown upside that comes from a possible IPO or bidding war.”
With Insieme, Chambers expects Mazzola & Co. not to deliver a product for a new market, but to protect an existing one. Cisco’s biggest source of revenue is its pricey machines loaded with proprietary software that direct and process data flows. Insieme is working on a new approach called software-defined networking. It will perform the same task as Cisco’s costly units by running software on everyday PCs.
The bottom line: The spin-in strategy has created important products for Cisco but enriches a few stars at the price of lower morale.