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JUNE 14, 2004
By Peter Burrows This Deal Might Reveal Cisco's Weakness Observers wonder if the rumored buy of Procket Networks is a sign that Cisco's much-hyped CRS-1 router isn't as good as promised Cisco Systems (CSCO ) has done a lot of acquisitions over the years, but none will raise as many questions as the one networking-industry insiders say is now in the works. Sources on June 10 said Cisco was in talks to buy Procket Networks, a maker of superfast "core routers" that form the Internet's backbone. This comes less than three weeks after Cisco announced its own supposedly killer product in that class. "I'm absolutely stunned. You could blow me over with a feather," said one former high-ranking Cisco executive upon hearing the news. "How are they going to explain this?" So far, Cisco isn't explaining anything. Both it and Procket declined to comment on or confirm the deal, and sources now say that Foundry Networks also might be a potential buyer. But if the rumors are true, Cisco will indeed have some explaining to do. It unveiled its new Carrier Router System 1 (CRS-1) at a much-hyped May 25 luncheon to mark Cisco's 20th anniversary, declaring the product a major milestone in its history. DECLINING SHARE. While Cisco has long dominated the market for networking gear purchased by corporations, it has struggled to win customers for top-of-the-line "core routers" that phone companies and Internet service providers (ISPs) use to serve millions of customers at a time. While corporations can tolerate a few hours of downtime a year on their internal networks, these high-volume carriers need bulletproof reliability and a host of other specialized features. At the May 25 event, Cisco executives waxed optimistic that CRS-1 would be truly "carrier-grade" and make the company a top beneficiary as these carriers roll out new services ranging from movies-on-demand to voice over Internet prototol (VoIP) phone service. Cisco positioned the product as no less than "the foundation for the future of communications." At the moment, however, Cisco's foundation in the $19 billion carrier-equipment market looks a bit shaky. While it's still gaining share overall vs. troubled incumbents such as Lucent Technologies (LU ) and Nortel Networks (NT ), its share is heading south in the $1.5 billion core-router market. In this segment, Cisco has seen its hold on this market fall from 69% in late 2002 to 59% in the first quarter of 2004, mostly because of gains made by hard-charging Juniper Networks (JNPR ). (For a Q&A with Juniper CEO Scott Kriens, see "'There's One IT Market: The Planet'".) DISAPPOINTMENT IN CHINA. Since carriers are trying to replace many disparate voice, data, and video networks with one Internet-based network, the core router in these "converged" new arrangements could well determine much of the other gear these customers buy. "As carriers move from legacy networks, the supplier that captures the core is the lead horse," says JMP Securities analyst Sam Wilson. "If you come in second, eventually you're going to get relegated to declining market share" in the overall carrier market. Other signs of trouble at Cisco are emerging. In recent months, it failed to win two closely watched core-router deals in the booming China market, where the government is behind a massive upgrade of the nation's core Internet infrastructure. China Telecom (CHA ) recently struck a deal with Huawei Technologies -- which uses the core router from startup Avici Systems (AVCI ) -- to upgrade the network in bustling Guandong province. And China Unicom chose Lucent, which uses Juniper core routers, in a deal signed in late 2003. Notes Lehman Brothers analyst Jiong Shao: "Competition is intensifying in China for Cisco in carrier core routing." A Cisco spokesperson says the outfit continues to win large contracts in China and around the world, pointing to a recent wide-ranging alliance with Ericsson aimed at selling gear to phone companies. "IT'S ABOUT TIME." Ironically, the long-awaited introduction of CRS-1 may actually get some customers to give rivals a look. It's the first Cisco product that doesn't run on the company's IOS networking software. As a result, clients that had grown used to buying a full slate of compatible gear from Cisco no longer have that option, at least for now. "That's going to create a lot of opportunity for companies like us," says Steve Kauffman, CEO of Avici Systems. Buying Procket would raise more questions about Cisco's carrier strategy. Given the price tag -- which sources put at around $80 million -- Cisco may well argue that the deal was simply an affordable way to hire Procket's talented team of 100-plus engineers, many of whom once worked at Cisco. But since Cisco has never before bought a routing concern -- after all, the giant invented the technology -- many investors and potential customers would likely conclude that Cisco knows the CRS-1 isn't all its cracked up to be. Indeed, the CRS-1 has received only tepid reviews from analysts and customers contacted by BusinessWeek Online. "Customers have been waiting for this product for two years," says JMP's Wilson. "Cisco is making tremendous fanfare, but the industry is thinking, 'It's about time.'" Also, most analysts expect Juniper to leapfrog Cisco with an even more powerful core router in the next few months. IN DISARRAY? And while Procket's flagship Pro/8812 router has garnered high marks for its breakthrough technology, which includes unique chips and an ambitious operating system, buying Procket won't be a panacea for Cisco. One of the best-funded startups in history, Procket raised -- and then burned through -- around $300 million since it was founded in 1999. The outfit has been raising more money in recent months, and it logged revenues of around $10 million in the first quarter, giving it a paltry 1% share of the core-router market. What's more, insiders say it would take months and much more investment to make Procket's hardware work with IOS -- or the new IOX software that CRS-1 runs on. Otherwise, Cisco would have to support and sell two competing product lines, a confusing, inefficient strategy for one of high-tech's most well-managed businesses. Given all that complexity, rivals are hoping Cisco pulls the trigger on this particular acquisition. "It would be a sign that they don't have the goods that they need, despite spending $500 million" on CRS-1, says Avici's Kauffman. "It [would] suggest they were in some disarray." And that wouldn't be a familiar place -- or a good one -- for Cisco to be, in any market.  Burrows is BusinessWeek's Computer editor, based in Silicon Valley Edited by Patricia O'Connell
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