Almost every large technology company, if it wants to remain relevant and avoid being left behind, needs to make acquisitions. Cisco Systems (NASDAQ:CSCO), the leading provider of networking hardware, is no exception. The company has long been highly acquisitive, and its push into software in recent years has led it to buy a slew of software companies.
One such software company is AppDynamics, a provider of a performance-monitoring platform. Cisco announced the deal to buy AppDynamics on Jan. 24, and it seemed to fit the mold of a typical Cisco acquisition. Previous acquisitions include companies like ContainerX, a container management platform company, and Jasper Technologies, an Internet of Things platform company. Cisco wants to sell solutions, not boxes, and these acquisitions further that goal.
But the acquisition of AppDynamics was odd, and it's made me question whether I trust management to make good decisions. Nearly five months later, I still can't believe Cisco shelled out $3.7 billion for AppDynamics.
A last-minute deal
AppDynamics was set to go public at a valuation of less than $2 billion, not far from its last private valuation of $1.9 billion. The day before shares were to be offered to the public, Cisco swooped in and bought the company. Negotiations reportedly lasted just 72 hours, with Cisco ultimately agreeing to pay $3.7 billion in cash and assumed equity awards.
For AppDynamics, there was no bad outcome. If a deal didn't happen, the company would have gone public, giving early investors impressive returns. With the potential for the stock to soar following its IPO, the company needed a lofty premium from Cisco in order to justify selling itself.
Had Cisco attempted to buy the company months earlier, prior to the start of the IPO process, it would have likely gotten a much better deal. Cisco could have also waited for the company to go public, buying it at a lower price if shares failed to perform well. Instead, Cisco paid nearly double the last private valuation, buying at a time when it had no negotiating power at all.
The price Cisco paid for AppDynamics was excessive, to say the least. The company generated $158 million of revenue through the first nine months of 2016, which put it on pace to produce around $234 million of revenue for the full year if its growth rate held up. Cisco paid a whopping 16 times sales. The company also isn't profitable, losing $95 million through the first nine months of 2016.
Acquiring money-losing companies at giant multiples of sales is fine in my book if the acquisition is small, and the purpose is to integrate the acquired company's technology. A big technology company like Cisco can't thrive in the long run without making acquisitions, and those acquisitions are generally not going to be cheap. But when the price tag is measured in the billions of dollars, I expect Cisco to carefully weigh its options. Paying nearly twice the expected IPO price the day before the IPO in a rushed deal seems like a poor decision to me.
I'm still a Cisco shareholder, and I still think the stock is a solid investment. But it's important to avoid putting stocks you own on a pedestal, ignoring mistakes and risks. My hope is that Cisco will be more disciplined with acquisitions going forward. If it's not, I may need to re-evaluate my investment in the company.