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Online Extra: Seeking Good Buys, Not Large Ones


Since Cisco (CSCO) went public in 1989, it has been one of the most reliable rapid growth stocks in the world. That's in large part due to Cisco's well-honed merger and acquisitions abilities. Not all of its 95 acquisitions have been megahits. But when the process clicks, Cisco's vaunted sales force can turn a promising networking product into a multimillion-dollar goldmine.

Can the networking-gear maker keep finding targets? At $22 billion in sales, the giant has to find more than $3 billion a year to hit the 15% growth it covets. BusinessWeek Computer Editor Peter Burrows sat down with Dan Scheinman, Cisco senior vice-president and M&A chief, to talk about how the company can keep priming the growth engine. Following are edited excerpts of their conversation:

Q: Cisco's stock is down 39% since early 2004, and many investors are concerned about the law of large numbers. Yes, the company laid out a detailed plan to grow 12% to 15% per year. But at $22 billion in sales, are there really markets that are big enough for Cisco to hit those targets -- and still maintain its profits?

A: We were at $29 at this time last year [vs. about $18 in early February, 2005], and what did it mean? Did it mean our growth prospects this time last year were better than they are now? Not dramatically.

The company is in good shape, and I wouldn't trade my cards for anyone else's cards. We have a great hand.

Q: But where will the growth come from?

A: The switching and routing markets are great markets, and they're in the midst of a huge transition from transport [just moving bits to their destination] to services [applications like telephony, security, etc]. Telephony is clearly a great market for us. We came from nowhere to being the third-largest vendor of telephone equipment. Companies have been trying to crack that market for the last 40 years, and no one did. But we did it.

So there are great big opportunities for the company, and our job is to execute. We're in great markets that are growing.

Q: But haven't you lost the lead in Internet telephony to Avaya (AV)?

A: If you take out their acquisitions of services businesses, their revenue in their most recent quarter shrank! The reason for that is because we're winning that battle. We're winning the Avaya customer base.

Q: Still, the math is daunting. Not only do you have to find new multibillion-dollar markets, they have to be ones that are profitable enough to enable the company to hit its goal of 65% gross margins -- an unthinkably high number for a hardware concern.

A: I'm very optimistic. We're just in the beginning of the networking era, and I've been hearing that same argument since I joined in 1992 -- and we've found seven more [switching, security, consumer networking, wireless networks, storage networking, optical networking, and Internet telephony]. Every time the stock goes down, people say, "Aha, this is the end."

Q: Your management team spelled out a very detailed -- and very long-range -- plan for growth at the December analysts meeting. Why?

A: The management team is very cognizant that our investors want to hear our story going forward. During the first three to four years of this post-bubble environment, we've been very near-term in our forecasts. We just thought that maybe it was time to poke our heads out of the sand and take a longer-term view.

Q: What kind of deals are you looking for? Are you being aggressive enough?

A: First off, let me say that I'm the post-bubble M&A dude at Cisco. [After I took over the job], we had two goals we wanted to focus on. The first was to find new markets for the company. And there's market expansion [of markets the company is already in].

The first deal I did was Okina [in security]. We decided to go into the desktop-software business right in the middle of the downturn -- and it turns out there's a strong No. 1, apparently, in that space! (Laughs) Well, it turns out Microsoft (MSFT) is a partner with us now, and we're succeeding with Okina beyond our wildest expectations.

Q: You've been doing more acquisitions in the last two years. How are they contributing to Cisco's growth?

A: Since the downturn, the deals we have done will contribute $1.3 billion -- that's a forecast -- for this fiscal year. That's over 5% of the forecast for the company. And we're over the revenue target [of $1.2 billion] that we committed to the CFO. Also, we're at an employee-retention rate of over 90%.

Q: Do you need to do more deals, and do bigger deals?

A: At the end of the day, we want to do successful deals. If we do deals just to do deals, that's a bad thing. They have to provide a return.

Q: So should we look for continued deals from Cisco?

A: It's all about finding the right opportunities. If you see venture investing rise, you'll typically see our M&A activity increase 12 to 18 months later [as those startups start to develop real technologies]. If it goes down, as happened in 2000 and 2001, it means there's not as much out there.

Q: What about bigger deals? There's a lot of whispers that you need to buy a leader in a big fast-growing market, such as storage.

A: We don't need to do a big deal.

Q: Why not? I had two sources tell me in recent days, unprompted, that they think Cisco should buy storage giant EMC (EMC).

A: Look at what happened to Symantec (SYMC) [which recently bought Veritas]. Everyone said, "Go do a big deal, go do a big deal." And what happened? The stock dropped -- because investors took it as a signal that things really are as bad as they thought in the core business.

And if you look at the history of big deals, it's hard to count on the fingers of one hand the number of successful deals. So the question becomes, what do we know that's different from all those other people that have charged up that hill? And we'd have to think that something we were doing is not working. And what we're doing is working.

Q: How many deals can you do?

A: If we start doing one every other week, we'd have problems. But once a month we know we can do. The key is to find the good deals...and then execute like heck. And we're showing we can do that.

Q: Some investors think you'll only hit your growth target if you're willing to get into fast-growing -- albeit less profitable -- businesses. That's what Cisco did with the Linksys home-networking subsidiary, and it has done phenomenally well.

A: If a company has 35% gross margins but gets to 18% net income, we'll go for it [Cisco manages its business so as to deliver a 20% net income]. Linksys' net margins are really good. To the extent that we can find businesses that don't have the top-line margins but can deliver the bottom-line margins, are we interested? Absolutely. What we don't want is to buy a 35% gross margin biz with 2% net margins and fool ourselves into thinking we can change them. EDITED BY Edited by Beth Belton


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