Cisco to Buy Linksys, Enter Home Market

The deal, valued at roughly $500 million, is expected to close during Cisco's fiscal fourth quarter. It will create a new Cisco subsidiary that will keep, at least for now, the Linksys name and product line alive. The unit will continue to be run by Victor Tsao, Linksys CEO, who will report to Charlie Giancarlo, senior vice president and general manager of product development at Cisco.

One Linksys distributor that caters to SMB VARs and solution providers said the deal could turn out to be a significant boost to Linksys, giving it unprecedented marketing muscle. However, he added, Cisco would be wise to leverage the knowledge of the existing Linksys management team, which has extensive ties to retailers, online resellers, mail order companies and other solution providers.

Founded in 1988, Linksys has grown to 308 employees and achieved the No. 1 share in home networking products, according to Cisco. According to figures provided by Cisco and compiled by Dell'Oro Group and Synergy, the worldwide consumer/SOHO networking market is expected to grow from $3.7 billion to $7.5 billion between 2002 and 2006. Cisco "believes the market is at critical inflection point and [that] this is the right time and right way to enter it," said Giancarlo. He added that the strong global presence of Cisco will help build and enhance the Linksys distribution channel and help the company with its geographic expansion.

Tushar Kothari, vice president of new business ventures at Cisco, said Thursday that he expects a modest portion of the existing Cisco partner base will add Linksys products to their solutions portfolios. Given that these companies generally focus on different market segments than most of the existing Linksys partners, it isn't likely that this activity will result in significant channel conflict.

"Linksys is a very successful leader in [the SOHO market,] so we are very proud to have teamed up with them," said Kothari, who added that he will soon join the Linksys management team.

Prior to the acquisition, Cisco considered launching a foray into the SOHO market itself. However, the company concluded that it might take as long as three years and a significant financial investment to get up to speed in that market segment. After evaluating its options, acquiring Linksys turned out to be a more attractive alternative.

Cisco has dabbled in lower cost products before, but generally stayed out of that business, believing the commodity nature of those products was incompatible with Cisco's traditional business model. The high R&D investment required to produce world-class products targeted for business and corporate users did not work when it came to commodity products. This time around, however, Cisco is confident that the new approach, which revolves around running Linksys as a separate division and relying on outside product developers and manufacturers, will produce the returns that the company desires. During a conference call on Thursday with members of the financial community, Cisco officials expressed confidence that Linksys could produce net margins consistent with Cisco's goals, which are 20 percent or more. That's despite the fact the gross margins on home networking products have typically been in the 30 percent range for several players.

In a statement provided to the media on Thursday, Cisco said it expects the acquisition of Linksys to dilute by no more than $.01 to its fiscal year 2004 GAAP earnings per share (EPS.) Exclusive of acquisition charges, Cisco anticipates this transaction will add approximately $0.01 to its FY2004 pro-forma EPS. The transaction will be accretive to both GAAP and pro-forma earnings thereafter.