It is Hard to Grow Large Cap Tech Companies
I am often asked what my opinion is of Cisco. Is it going out of business because of white box? Should they buy Arista? Should they buy NetApp or EMC or Citrix or RedHat? The news today that HP is going to break into two companies tells me that we have reached a point where it is difficult to grow large cap tech that have multiple business units. No CEO of a large cap tech company wants to be the AOL/Time-Warner of this market era. A few thoughts on the subject of large cap tech companies.
1. When you are a $48B company like Cisco, it is really hard to buy something that would be meaningful or impactful on numbers. Meaningful in my mind is $1B in annual revenues that can be grown to $3B within 24 months. The challenge for the Cisco M&A team is that any company that has $1B in annual revenues is most likely a public company and is playing in global markets. If they are not a public company, it is because they are not growing or they are just waiting to go public with equity markets near all time highs.
2. I read a few months ago a post from an analyst who write that Cisco should buy Arista. Ummm…that is a stupid idea. The last thing Cisco needs is another product line. I would argue that Cisco has too many product lines and that these product lines do not have enough technical and cost synergies across the business units. The Internet of Things #iot requires quite an R&D budget and might be too lofty a goal with the current product set. Cisco sells $3.6B a quarter in switching. You could add another ~$650M from the data center group and I would not quibble. $3.5B or $4B, either way I am willing to assume that the profit for the switching group is ~$2B a quarter. Arista sells $150M a quarter and is on track for $500M a year in sales (awesome job by the Arista team) with a $5.5B market cap. I am not an investment banker but these numbers do not work out together.
3. Cisco is trapped by their success. They continue to buy small startups to incorporate their technology, but these deals are not impactful and I would hypothesize are really a distraction. Cisco needs to accept that the 1990s are over and buying discreet technology startups is not a strategy for success. Large M&A deals like Stratacom, Webex, SA, and NDS are hard to afford as equity multiple expansion makes these deals too expensive.
I believe that large companies can innovate and that is what Cisco needs to do.
What I believe is that large companies often have leaders who do not fully understand how their company functions and thus cannot realize the full potential of their R&D organization. If VCs and small companies could innovate better, then there would not be so many venture-funded failures. In technology markets, large companies can innovate and should win against small companies if they have strong leadership and their leaders know how to deploy a process of fast failure. Here are some examples of large company innovation and disruption that has had commercial success:
- IBM: 360 Mainframe, AS/400, RS 6000 and that thing called the PC
- Apple: Apple was a $2 stock when it introduced the iPod. Then came the iPhone and the iPad.
- Microsoft Office
- Nortel: First digital phone switch called DMS-10 and first commercial 10G LH system and later the 40G coherent signaling
- Western-Electric (Part of AT&T) 5E Switch
The truth is that big companies can innovate when they stop impressing shareholders with their growth numbers. For large technology companies, the road to innovation is often the result of a process that is outside the main R&D effort to avoid being trapped by the bureaucracy. The difference between a startup and a large company from an R&D perspective is that a small company is focused on what is needed to sell the product and how to get it done as quickly as possible. Large companies have mature, often bureaucratic decision making processes that weight legacy product lines and legacy customers too heavily.
If you were to look at most mature, large tech companies you would see that most of the employees face inward – not outward towards the customer and market. I once told a CEO of startup that in my experience, an early stage startup is all about failure. The faster you fail, the faster you will succeed. A startup is a code word for cycling through as many test problems as fast as possible until a proof is found. For a startup or a growth tech company, proof is measured by new customer adoption and that seems to be the same for large tech companies who innovate outside of the mainstream of their Taylorized R&D processes.