Has Cisco got its sums wrong?
Has Cisco got its sums wrong?
It was announced last week that Cisco Systems is to acquire pay TV software and conditional access provider NDS for a massive $5Bn.
Cisco said that the deal will complement and accelerate the delivery of its Videoscape video platform, and broaden Cisco’s opportunities in the service provider market, expanding its reach into emerging markets, such as China and India, where NDS has an established customer footprint.
It’s certainly true that NDS is something of a leviathan within the media industry. It employes 5200 people and last year has revenues just short of $1Bn. Of the estimated 430m digital pay-TV households worldwide, 115m of them, over 25%, have NDS content protection within their set top boxes.
However, despite its impressive size, market penetration and reputation (they recently won an $18m lawsuit against Echostar, clearing NDS of allegations of piracy), the company is barely profitable and is also carrying over $1Bn of debt.
The $5Bn dollar purchase price could be something of a windfall for 49% owner News Corporation. After all, with their recent problems over the phone hacking scandal, and now with UK media industry regulator OFCOM questioning whether News Corporation’s partial ownership of BSkyB meets a “fit and proper persons” test, a windfall of several billion dollars from the sale of NDS will be a welcome distraction for News Corp.
The question though is whether Cisco can extract value from the acquisition. Cisco’s annual revenue run rate is about $45m, and they are highly profitable, with net profitability at around 20%. No doubt they will be looking to get the NDS business unit to the same level of profitability. Their stockholders will expect nothing less.
However, as NDS has the TV encryption sector’s largest market share, sales growth in its traditional pay TV market will be difficult. And as 80% of its staff is in R&D, driving cost out of the business would mean slashing the development budget. This is not generally a good thing for a company where innovation is essential in order to protect its market leadership.
It’s clear that Cisco is trying to focus on television. Cisco has made multiple acquisitions as part of its strategy to build out its Videoscape platform, including last year’s purchase of ingest and transcoding specialist Inlet Technologies for $95m, and bnI Video for $99m.
However, Cisco has so far only been able to establish its Videoscape platform in a handful of customers in the telecoms and broadcast services sectors. And given that there were a number of layoffs in the Cisco team that supported these sectors last year, does the acquisition of NDS look increasingly like a desperate move by a company that is struggling to maintain its direction in TV?
NDS is hardly known for providing open, standardised platforms. In fact its real value to its traditional customer base is its secrecy and the closed nature of its offering. This does not sit well with the type of customers Cisco is trying to attract to Videoscape.
But is the television business large enough to warrant the level of investment that Cisco is clearly making?
Estimates vary, but the annual video infrastructure and equipment market is reported as between $13.2Bn (ACG Research) and $16Bn (Screen Digest) Worldwide. There is a further $9Bn of service revenue within the sector.
Findings from ACG Research’s Q4 2011 report into the Service Provider Video Infrastructure (SPVI) market indicates that the market reached $4 billion for the quarter, and that Cisco is the clear market leader in this sector with an approximately 60 per cent market share. Competitors include Alcatel Lucent and Motorola. So unless this market sector is set to grow exponentially, then it is difficult to see how Cisco can use the acquisition of NDS to boost its sales volumes.
There is certainly growth in Over The Top television services, but any market can only sustain a level of investment proportional to its size. With most advertising supported broadcasters being squeezed on profits, and pay TV providers being pushed to offer additional services to subscribers at no extra cost in order to reduce churn, then this can only be funded by content paid for by the consumer. It’s ‘brave’ to forecast tens of billions of dollars in additional pay per view revenues when we are still in the grip of a global recession.
Is Cisco a victim of its own success?
In Harvard professor Clayton M. Christensen’s book The Innovator’s Dilemma, he points out that when markets expect 20% annual growth, for a company the size of Cisco, that means $9Bn of extra sales. There are not many new market sectors that can provide that level of additional revenues.
Christensen states that outstanding companies can do everything right and still lose their market leadership. He goes on to say that focusing on “disruptive technology” is one way to avoid this fate. Perhaps this is what Cisco had in mind when they started developing Videoscape. However, this was a major departure for a company that focused on selling, essentially, hardware. Certainly there is clever software within Cisco network products, but this is only exposed to those clever network engineers who are happy to type UNIX command line instructions. Videoscape was as much a concept as a technology. And Cisco has thus far failed to communicate this concept effectively.
Maybe by buying a company that has an established reputation with TV companies, and is present in 115m homes, Cisco believes that this will strengthen its Videoscape offering. But if Cisco is hoping to woo the likes of Netflix and Hulu, or be the backbone for services such as Streampix from Comcast, HBOgo, ESPN and Showtime, then it may have to do better than buying a company best known to media companies for satellite TV encryption services.
ⓒ Jeremy Bancroft, Media Asset Capital – March 2012