Cisco Bids for BroadSoft. Why?


By: R. Scott Raynovich

Cisco (CSCO) appears to be ramping up its acquisition activity toward cloud software plays with this morning's bid for BroadSoft (BSFT) for $1.9 billion.

Both Cisco and BroadSoft are players in unified communications (UC), the hardware and software tools used by individuals and businesses to communicate with each other over the Internet, though Cisco has a larger revenue and product based in UC. BroadSoft went public in 2010 with a focus on the so-called softswitch market, which routes voice-over-IP (VOIP) calls through IP-based switching systems. It has since broadened its products into adjacent services such as unified communications (UC). Other big players in UC include Avaya, Citrix (CTXS), and Microsoft (MSFT).

What's up with that small premium?

But both BroadSoft and Cisco investors might have a few reasons to balk at the deal. Cisco has offered $55 per share, a very small premium for BroadSoft shareholders. BSFT shares rose 0.77 (1.44%) today, immediately closing the gap toward the bid price, trading at $54.70 in midday trading and rewarding investors with a mere two percent premium over Friday's price. Favorable buyouts reward investors with larger premiums, often as high as 20 percent or more.

So the first question to ask: Why was the premium so small? Usually this represents a lack of competitors interested in acquiring the target, which is akin to being one of the last players to be picked for a basketball team.

There could be several reasons for this: BroadSoft is a very specialized business, it's not that large, and the financials aren't stellar. Recently the company has been experiencing slowing growth, a very small profit margin (in fact in the last two quarters it has announced small losses), and increased risk of commoditization in a crowded and dynamic market of IP-based communications and collaboration tools.

While there was some chatter this morning that other companies might be interested in BroadSoft, it's hard to see anybody stepping up. If you want to consider a few companies that would do the deal in theory, Microsoft has been active in UC and it's been rumored in the past that Amazon has looked at this area.

There was some chatter this morning that other bidders could emerge, with some sell-side analysts saying full value of the BroadSoft shares is $60-$70 a share. But, because of the reasons we have already mentioned, be wary of this speculation.

At the recent price, BroadSoft trades at a price/earnings (P/E) ratio of about 20 based on forward 12 months earnings estimates; its price/sales ratio is about 5. These are not especially high multiples which might be explained by the fact that BroadSoft growth has slowed in recent years -- its year-over-year revenue growth is about eight percent. It also has a relatively low operating margin of about two percent over the past 12 months, according to public data.

Why Cisco likes Broadsoft

BroadSoft's specialization, which makes it unattractive to many other buyers, may be exactly why it's attractive to Cisco. It's relatively small, at about half a billion dollars in revenue, and its profit margins are small. But Cisco could fold it into its broad UC portfolio and start selling away. It also could use BroadSoft's traction with telecom partners to expand the sales channel. Cisco gets the usual merger benefits of consolidating sales, marketing, and management (layoffs).

Cisco says that BroadSoft is complementary to its existing UC portfolio and it would expand Cisco's channel to sell UC products through service providers.

Cisco VP of corporate business development Rob Salvagno wrote about the deal in a Cisco blog this morning, pointing to BroadSoft's large base of customers and telecom resellers.

"Collaboration is the first step to business digitization and BroadSoft has partnerships with over 450 telecom carriers in 80 countries -- including 25 of the top 30 globally -- to 19+ million BroadSoft business subscribers," wrote Salvagno. "BroadSoft's portfolio is complementary to our existing on premises and enterprise-centric Hosted Collaboration Solutions (HCS), as well as Cisco’s overall cloud investment strategy."

Before Cisco announced that it will discontinue its current breakdown of revenue buckets, collaboration was its third-biggest revenue group, at about $1 billion. However, this number hasn't changed in about two years, and it includes Cisco's Webex web conferencing business, a company Cisco bought for $3.2 billion in 2007. Webex added revenue but hasn't been transformative for Cisco. BroadSoft looks like a similar deal. For a full view on Cisco's corporate strategy, take a deep dive into Cisco's growth challenges.

Bottom line? Cisco is bidding on BroadSoft to boost its cloud-based communications revenue, which is a major goal of the company. By adding subscription software-based revenue to its portfolio, Cisco can diversify faster away from hardware. Diversifying revenue into software businesses is likely to continue to be a focus for the company over the next year.