Breakingviews: Cisco’s $28 bln spelunking yields dicey deal

Sometimes a mud-covered object is a gem. Often, though, it’s just quartz. That’s the issue facing Cisco Systems after it announced on Thursday a $28 billion acquisition of big data and cybersecurity outfit Splunk. The all-cash deal banks on Cisco drumming up growth – and the $215 billion networking giant assumes the risk for executing it.

The company run by Chuck Robbins is looking to diversify away from its original business: selling hardware like routers and switches that connect computers and communication networks. Splunk in theory has enough to offer. Its software helps people monitor and search large pools of data. Ideally, Cisco’s networking expertise and Splunk’s ability to gain insights might yield cybersecurity products that can better predict attacks, say. Plus only about a third of Splunk’s sales are international, while over 40% of Cisco’s revenue comes from outside of the Americas. Cisco’s marketing heft could expand Splunk’s network and help it land more big contracts.

The price is also potentially right. Cisco is paying about 7 times Splunk’s estimated revenue over the next year, according to LSEG data. Even with a chunky 31% equity premium, that’s slightly below Splunk’s average valuation over the past five years.

But Splunk may be relatively cheap for a reason. In 2020, the company, which had been growing its top line at 30% or above in previous years, hit a wall. It’s cloud-based offerings were relatively slow to take off among customers. That is the main tenant of its growth strategy, but analysts only predict 12% overall expansion next year.

Worse, Cisco didn’t tout any cost savings from the deal. That may be a small part of a strategy to get around antitrust regulators, but its own shareholders aren’t buying it. The company lost $10 billion of its value on Wednesday. At the statutory tax rate, the deal would represent about a 3% return on Cisco’s investment. To earn a 10% return, it would have to nearly quadruple operating profit after-tax.

If Cisco can bring back old growth rates and higher margins, then it could justify the deal in less than five years. But that seems tough for a company whose own top-line growth has slowed. The transaction is the largest Cisco has ever found. To bring forward a gem, though, it’ll need to keep spelunking.