Networking equipment giant Cisco (NASDAQ:CSCO) generates nearly half of its revenue from routers and switches -- two highly commoditized, slow growth markets. Its routing revenue fell 4% last year as its switching revenue stayed flat. IDC also reports that Cisco is losing market share in both markets to aggressive rivals like Huawei.
In response, Cisco has been investing heavily in higher growth businesses like service provider video, collaboration, and security solutions. Security is the fastest growing business of the three, posting 13% annual sales growth last quarter and accounting for 4% of Cisco's top line.
Over the past few years, Cisco beefed up that business by acquiring security companies like threat protection firms ThreatGRID, SourceFire, OpenDNS, and Lancope. But looking ahead, many analysts expect Cisco to dip into its free cash flow ($12.4 billion over the past 12 months) and make additional purchases across the cybersecurity sector. Let's take a closer look at the two most likely targets.
FireEye (NASDAQ:FEYE) is frequently cited as a takeover target for Cisco, since it's a "best in breed" threat prevention firm which was notably the first cybersecurity company to be certified by the U.S. Department of Homeland Security. Buying FireEye would strengthen Cisco's security portfolio, and the company could bundle all these technologies directly into its networking hardware and software. These bundles could widen its moat against rivals like Huawei and HPE.
FireEye has plunged 60% over the past 12 months due to slowing sales growth, jarring management changes, and its alarming cash burn rate. But it now has a fairly low enterprise value of $1.9 billion -- not a bad price for a company that generated $623 million in revenues last year. Moreover, FireEye's revenues are still expected to rise 16% this year and 15% next year. FireEye is unprofitable, but its operating costs would probably decline dramatically after being integrated into Cisco's security unit.
However, FireEye reportedly rebuffed several takeover attempts earlier this year, because its suitors offered less than the $30 per share (140% higher than its current price) it wanted. It's also believed that Kevin Mandia, the company's new CEO, is less interested in selling the company than his predecessor, David DeWalt.
Over the summer, several reports claimed that Cisco's channel partners were urging it to buy Imperva (NYSE: IMPV), the leader in the niche market of web application firewalls (WAF) which shield individual apps from specialized attacks. Sandler Research estimates that the WAF market could grow at a compound annual growth rate of 17.3% between 2014 and 2019.
Speaking to CRN, an unnamed Cisco Gold solution provider suggested that buying Imperva would help Cisco "fill in some key holes" toward becoming an end-to-end security provider. Greg Kushto, director of Security and Enterprise Networks at Force 3, also told CRN that Imperva excels in areas where Cisco is weak, including data security, encryption, and data masking.
Like FireEye, shares of Imperva have slumped nearly 30% over the past 12 months due to slowing sales growth, mainly attributed to extended sales cycles and the smaller size of larger purchases. Analysts expect Imperva's sales to rise less than 7% this year to $250 million before possibly accelerating back to 20% next year.
But unlike FireEye, Imperva is still trying to sell itself. Bloomberg claims that Cisco and IBM have both expressed interest in buying the company, which has a fairly low enterprise value of $1.3 billion. Imperva also faces pressure from activist investor Elliot Associates, which holds a stake of nearly 10% in the company, to explore "strategic and operational opportunities" like a potential sale.
Will Cisco buy these companies?
It seems more likely for Cisco to buy Imperva than FireEye, since it's actually looking to sell. But I also wouldn't rule out a hostile bid for FireEye, since the company is much cheaper than many of its peers with an EV/Sales ratio of around 3. Imperva, for example, has an EV/Sales ratio of 5.
Investors should never buy a struggling company in anticipation of a buyout, but FireEye and Imperva's "best in breed" strengths and beaten-down prices could be too tempting for companies like Cisco to ignore.