Networking Gear: New Arenas, Iffy Stocks

Cisco's WebEx deal shows it's moving beyond hardware, but overall, prospects for shares of communications equipment companies are uncertain

by Karyn McCormack

Cisco Systems' (CSCO) recently announced $3.2 billion deal to acquire WebEx (WEBX) will take the bellwether communications equipment maker beyond routers and switches that transport voice and data over networks, to applications software—putting it directly in Microsoft's line of fire (MSFT) (see BusinessWeek.com, 3/16/07, "Cisco Ups Ante in War with Microsoft").

"This evolution stems from Cisco's longstanding vision that networking will evolve from a simple transport medium into an intelligent communications system," says Ari Bensinger, who follows communications equipment stocks for Standard & Poor's Equity Research.

Indeed, equipment suppliers are faced with the constant threat posed by new technologies, Bensinger says, with traditional products regularly replaced by more efficient and functional equipment. Some players are focusing on niche growth areas, such as components for electronic program guides and security in cable set-top boxes and video surveillance used in security systems. His two favorite stocks that are players in these areas are NDS Group (NNDS), based in Britain, and NICE Systems (NICE), based in Israel.

Though the industry is seeing strong demand overall for new gear to build fiber-to-the-home and Internet-protocol TV services, company sales visibility is low and can swing from one quarter to the next, Bensinger warns. In turn, communications equipment stocks could be on shaky ground this year.

BusinessWeek.com's Karyn McCormack spoke with Bensinger on Mar. 27 about communications equipment companies. Edited excerpts from their conversation follow.

Note: Ari Bensinger is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies that he researches. All of the views expressed here accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed.

What do you think of Cisco's plans to acquire WebEx?

WebEx is an interesting acquisition because it's primarily a subscription-based business and veers from Cisco's unit-driven revenue model. It seems like Cisco is gradually evolving from a hardware vendor that sells transport infrastructure equipment to a solutions provider of communication software and services. This evolution stems from Cisco's longstanding vision that networking will evolve from a simple transport medium into an intelligent communications system. An expansion into this market will set the stage for some desktop turf wars against Microsoft, a company that has not been a major competitor to Cisco before.

Do you see more deals in general among communications equipment companies?

There's certainly been a sharp increase in M&A [mergers and acquisitions] over the last two years. Some notable examples include Cisco acquiring cable set-top box maker Scientific-Atlanta and the cross-border combination of France's Alcatel (ALA) and U.S.-based Lucent. We believe these deals underscore the important role that convergence will play in the industry, as equipment vendors that cannot offer a complete solution to support voice, data, and video will be at a huge disadvantage.

Given that there are only a few large, integrated equipment suppliers left in the market, we believe that most transactions going forward will be on a smaller scale, mostly to fill product-portfolio holes.