Cisco Systems Inc.: Spending $635 Million to Join the Best Internet of Things Stocks

Image source: OpenDNS.

On Tuesday morning, Cisco Systems (CSCO 0.45%) announced a $635 million all-cash buyout. The networking giant is picking up privately held OpenDNS, in a move designed to boost Cisco's position in the blossoming Internet of Things market.

Here's how OpenDNS fits into Cisco's machine-to-machine business plans.

What is OpenDNS?
OpenDNS is known for a suite of Internet services that can improve the security of your network. By replacing your service provider's DNS servers with those run by OpenDNS, you get to exclude known hot spots for scams and viruses, add your own blacklists or whitelists, and generally manage what types of online resources your family -- or business -- should be able to use. These servers may also return Internet address data quicker than the default servers do, but that's hit-and-miss.

OpenDNS builds much of its security filter information on input from existing users, both private and corporate. This way, Cisco gets its hands on that hand-culled list of online security threats, along with a substantial customer list. OpenDNS serves 65 million users today, including more than 10,000 organizations of various sizes.

All of these features are free for personal use, which explains the "Open" bit of the OpenDNS moniker. The company also runs hardened name services for corporate clients, which pay extra for stronger security filters and enterprise-class feature management.

OpenDNS even runs a special security service for fleets of mobile devices such as smartphones, laptops, and tablets. Here, information-technology administrators take over the responsibility for installing and maintaining the OpenDNS security filters from a central management console.

Both the open consumer-level service and the business-grade platform support DNSCrypt name query encryption. Alongside OpenDNS' security management tools, this is an open-source alternative to the Gabriel secure connection platform.

Gabriel developer VirnetX (VHC -3.22%) has sued Cisco for patent infringement in the past. Buying OpenDNS is not an automatic cure for that headache, DNSCrypt doesn't cover Gabriel's entire feature set, and OpenDNS is certainly not the exclusive developer or sole user of DNSCrypt technologies. Still, the move puts a little more intellectual-property distance between Cisco and VirnetX.

But that's not the big idea behind Cisco's $635 million OpenDNS purchase -- just a nice little bonus.

Image source: Cisco Systems.

So what's the big deal, then?
In Cisco's press materials, the company pointed to another layer of network security. "The acquisition will boost Cisco's Security Everywhere approach by adding broad visibility and threat intelligence from the OpenDNS cloud delivered platform," Cisco said.

It's a perfect fit for the Internet of Things -- a $19 trillion market in the making by Cisco's reckoning. A simple change of DNS servers (plus a ton of security work on Cisco's and OpenDNS' back end) upgrades the security of any device you choose, including the 50 billion Internet of Things connections Cisco foresees in five years. When the acquisition closes, Cisco will be in position to bolster data security in several layers -- from the data-reporting device itself, to the number-crunching servers at the other end, and the network equipment in between.

Of course, nothing is stopping Cisco from developing its own secure DNS solution, including management tools and support for encrypted network traffic. It's just faster and easier to buy an existing top-to-bottom service such as OpenDNS, fold it into Cisco's corporate structure, and move on from there. Why reinvent the wheel, or the secure domain name service?

OpenDNS founder and CEO David Ulevitch. Image source: OpenDNS.

What happens next?
If you're one of those 65 million OpenDNS clients, the company would like to assure you that nothing will change. "OpenDNS as you know it will continue to work as it does today," said founder and CEO David Ulevitch in a blog post.

That's based on promises Cisco is making to Ulevitch and his team, and OpenDNS' management believes it. "We didn't decide to sell OpenDNS. We decided to sell OpenDNS to Cisco. That's an important distinction," in Ulevitch's words. "Cisco is not buying OpenDNS for our individual components, but for the whole."

Cisco obviously knows what OpenDNS is doing, and has invested in the company's early venture-backing rounds. Thanks to this established history, I'd be shocked if this deal runs into serious integration issues.

That's the user impact. In business terms, this does look like a win-win-win-win idea.

The world's digital crooks will have a harder time penetrating Cisco's solutions, particularly among the sprawling array of connected Internet of Things devices. Hence, Cisco's customers might avoid some digital threats to which they are currently exposed. Cisco earns a big selling point -- stronger security for connected gadgets in the field -- plus a healthy list of existing OpenDNS clients. And aside from a large paycheck for OpenDNS and its venture capital backers, that team gains access to Cisco's global marketing and distribution footprint.

All for just $635 million, or about 7% of Cisco's trailing free cash flow. Looks like a good deal, and a smart one to boot.