Fool.com: Cisco Antes Up for IBM Networking Business (News) September 1, 1999

Cisco Antes Up for IBM Networking Business

By Bill Mann (TMF Otter) (TMF Otter)
September 1, 1999

IBM (NYSE: IBM) said yesterday that it has dealt its network equipment business to Cisco (Nasdaq: CSCO) in exchange for $2 billion and an agreement for IBM to supply customer service support and key parts to the Internet giant.

According to The Wall Street Journal, sources familiar with the deal say that Cisco will pay IBM about $300 million for its intellectual property, with the remaining funds being allocated for a five-year service contract.

The deal is a blockbuster for IBM, which will receive the aforementioned $2 billion in exchange for a loss leader division's intellectual property and customer base. IBM's network equipment component no longer fits with the company's new strategy of selling key parts and services to more nimble equipment providers in the networking arena.

In addition to the equipment sale, IBM announced that it obtained a contract from Cisco to provide parts and service support to Cisco's customers. According to Reuters, IBM will derive revenues on this contract estimated to be in excess of $3 billion.

The companies have a long history of co-developed products and services, but IBM's network hardware activities have been a sticking point blocking closer cooperation. Selby Wellman, Cisco's Vice President for Interworks Business Division, stated that the transaction has the effect of "removing a major constraint from the two companies doing everything together."

On the surface this would seem like a lopsided deal in favor of IBM, since it receives the cash for killing off a struggling division. But Cisco receives in return a slate of benefits that should quickly make its cash outlay seem like a bargain.

For starters, Cisco has bought out one of its major network hardware competitors, with top-line revenues in excess of $450 million per year. More importantly, Cisco can now farm out some of its technical support to IBM for network installations, an area that Cisco has sorely wanted to augment. Finally, by removing this obstacle, Cisco can more openly and fully integrate its networking technology with IBM's expertise in super computers, chipsets, and support services. The synergy between the two companies could add billions of incremental revenue for Cisco.

IBM on the other hand will gain access to the full customer base of a more agile partner. Over the last two years, IBM has been increasingly aware of the loss of revenue it has endured as other companies took advantage of the breakthroughs coming out of IBM's research and development efforts. This transaction signifies a greater willingness by IBM to recognize the potential of having its components and intellectual property utilized by other companies, rather than trying to release its own branded product.

By dealing its network hardware division to Cisco, IBM opens itself up to parts and service supply to Cisco's entire roster of customers. IBM is betting that the $300 million in cash it receives for the transaction will pale in comparison to the future revenue stream it will derive as a result.

In a related story, news of the deal rocked the stock of MMC Networks (Nasdaq: MMCN), which fell almost 40% before being halted for the day by Nasdaq pending a statement from MMC. MMC made a statement that it expected negligible sales to IBM in 2000, down from 25% of MMC's total revenues.

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