Cisco buys home networker Linksys

Cisco Thursday announced a definitive agreement to acquire privately held Linksys Group, the leading provider of wired and wireless network products for consumers and small businesses, for $500 million in stock.

The deal represents Cisco's entry into the high-growth consumer/SOHO market, which is expected to grow from $3.7 billion in 2002 to $7.5 billion in 2006 worldwide, the company says, citing data from Dell'Oro Group and Synergy Research. The acquisition is expected to close in the fourth quarter of Cisco's fiscal year 2003, which runs May through July. 

Linksys has more than 70 products, including wireless routers, access points, network adapters and print servers, as well as a full line of traditional wired products ranging from routers to network attached storage devices. There is no overlap with Cisco, even in low-end switches - Cisco's are managed and Linksys' are unmanaged, according to Linksys President and CEO Victor Tsao.

"We should be able to use some of Cisco's technology selectively later on for future products," Tsao says.

Linksys will be operated as an autonomous division of Cisco, its products sold under the Linksys brand through its existing retail, distributor and e-commerce channels. In addition, Linksys will have access to Cisco's sales infrastructure to address international markets and the service provider channel.

"This is our 81st acquisition, and for the first time the acquired company will be a standalone, separate division with its own sales, marketing, engineering and other functions," says Tushar Kothari, Cisco vice president of new business ventures. "We expect Linksys to operate with the current business model that they have."

That includes selling product through Dell's online channel. Dell is a significant low-end competitor to Cisco in the small/midsize business network market - so significant that Cisco terminated a resale agreement with Dell last year.

Kothari says Linksys will continue to oversee its channel structure, independent of Cisco's.

The Linksys Group was founded in 1988 and has 308 employees. The Linksys business, led by Tsao, will report to Charlie Giancarlo, Cisco senior vice president and general manager, product development.

Even though Cisco characterizes the acquisition as its entry into the home and consumer networking market, it is actually a reentry. Cisco repeatedly attempted to enter the market through internal development, dating back to the ill-fated CiscoPro effort in 1995, which was tailored to the home professional. 

Since then, Cisco formed and then disbanded a consumer line of business intenally; demonstrated its products in "Internet home" applications and at the annual Consumer Electronics Show; and has and continues to develop and offer a broad line of SOHO routers.

"What we learned through that entire process was that is was not a question of products, but one of business model," says Giancarlo, who used to direct Cisco's consumer line of business. "We had developed great products for these markets - a number of firsts for the home market - but these things could not be sustained in Cisco's traditional business model. The high R&D, high support cost, high sales cost, which works great in an enterprise and service provider environment, is not the right one for a consumer model. We believe this new business model will allow us to compete very successfully in that market."

Added Dan Scheinman, Cisco senior vice president of corporate development: "We also believe broadband is at an inflection point. The market is really starting to move towards mass-market. Linksys has managed to pull off the magic of having  innovative product, leading brand, leading customer support, as well as maintaining a very lean operating expense model. Those things allow Cisco to enter the market in a way that will make sense for the rest of the business."

The rest of the business will attempt to use Linksys as a way to create demand among service providers for Cisco's larger ticket items, analysts say.

"In the end, Cisco's goal is going to be to sell high-end networking equipment to the backend providers," says Kurt Sherf, vice president of research at research firm Parks Associates. "A real key to doing that is to figure out a need for why a service provider needs to increase their bandwidth capability. Home networking does that for them. So when in the third or fourth quarter, Linksys starts rolling out products that focus on multimedia connectivity, which we think will happen, eventually there are going to be capacity issues."  

Profits margins in the price-sensitive home/consumer network market are around 30%, while Cisco's are at 70%. Cisco hopes to earn "higher-than-industry-average margins" in home/consumer networks through the Linksys acquisition, Giancarlo says.

The Linksys purchase will also present a new cadre of low-end competitors to Cisco, such as Netgear, D-Link and Microsoft, which made a big push into the home/consumer market last fall. According to NPD Techworld, Linksys owns 40% of the retail networking market, trailed by Netgear with 12%, and D-Link and Microsoft with 8%.

"There are new competitors for Cisco," Giancarlo says, "but this is where Linksys has competed extremely well. In spite of everything else that took place in the market over the last six months, Linksys has picked up additional market share points. We believe that we'll be able to compete very favorably in this market."

Separately, Cisco brought more clarity to its VoIP product line - literally - this week with the acquisition of SignalWorks, a maker of software for improving the sound quality of IP phone conversations. For the full story click here.

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