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Cisco to pay divvy in 2011

Acquisitions are really, really, really, really, really hard

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John Chambers, chief executive officer and chairman of networking giant Cisco Systems, must be getting ready for retirement three to five years from now. Because yesterday at Cisco's financial analyst conference in San Jose, Chambers announced that the company would start paying out a dividend to stockholders beginning in 2011.

Chambers, who is 61, is not going to retire any time soon, of course, and is not just looking out for himself. Cisco was sitting on $4.6bn in cash and $35.3bn in short-term investments in the quarter ended in July. That cash hoard has more than doubled in the past five years as Cisco has boosted revenues by 40.6 per cent, to $40bn, and had wiggly profits that average around $7bn a year and that are trending slightly upwards. That's a lot of cash to have sitting around considering the revenue stream size.

With the company expanding into so many adjacent markets - such as servers, storage, consumer digital electronics and online services - where it is difficult to command the high margins Cisco gets from its routers and switches, and with likely and relatively small acquisition targets not going to dent that cash hoard, Cisco only has a few options with the cash. The company could boost its research and development, which has grown pretty modestly, from $4.1bn in 2006 to $5.3bn.

The company could make even more acquisitions, which is somewhat complicated by the fact that a large portion of that $39.9bn cash hoard is in overseas units, but as Chambers said in his keynote address at the analyst meeting, "acquisitions are really, really, really, really, really, really hard." Acquisitions are difficult if you don't have a culture that absorbs companies well and retains employees. Chambers reiterated that over 90 per cent of acquisitions fail, but then bragged that 70 per cent of the acquisitions that Cisco has done - and there are 141 of them - met or exceeded the bar Cisco's managers set when they pitched the deal to the board of directors.

Chambers does have some humility, and gave Cisco only a B grade in partnering, but then quickly added how well the company was partnering with EMC and VMware for its "California" Unified Computing System.

"We are the number three player in the US for x86 blades," bragged Chambers. "Number three. Analysts have us becoming, in the next quarter or two, half the size of the number two player. And this is a market that many said we would be exiting shortly after we entered."

As Cisco closed out its fourth quarter of fiscal 2010 in July, the company had 1,700 UCS customers. In under a year, that is five per cent of the Sun Microsystems customer base (35,000 unique companies) that Oracle paid $5.6bn (net of Sun's cash) to acquire earlier this year.

Cisco, Chambers said, had spent the past five years changing the company, making it innovate faster and operate well as it moved into adjacent markets and seized on market transitions. "The market transitions are not about competitors," Chambers lectured. "It is about you either catch this or you get left behind. And we are pretty darned good at this."

Cisco jumped from routers to switches, from ISPs to data centers, and is pushing deeper into data centers with UCS and out into tablet computers, cameras, and other consumer devices that will be the tools of the future of business and consumer collaboration - what Chambers calls "business social networking" and a boom that will affect business processes in the next seven to 10 years like assembly lines did manufacturing. All backed by Cisco's networks and systems, of course.

Cisco could do more share buybacks, but there is a limit to how far you can push this. Cisco has already pumped $65bn in cash buying back its own shares in the past nine years, the company's chief financial officer, Frank Calderoni, explained at the analyst meeting.

And thus, with R&D spending running at an acceptable level for the size of the company, acquisitions not being particularly attractive except in very targeted areas, Cisco is left with the remaining alternative for its cash: a dividend for shareholders during fiscal 2011, which ends next July.

Shareholders have been leaning on Cisco to let go of some of the cash, according to Chambers, who said the company "felt strongly that this was the right thing to do".

The annual dividend is expected to range between one and two per cent of the company's share price, which is currently north of $20 a pop.

IBM has been paying out dividends for most of its 99 years of existence, and Microsoft started to pay them in 2003. Most tech companies do not pay dividends, preferring to hoard cash and let their revenue growth, profit growth, and market share gains drive their stock prices. But at a certain point, you get your monopolies or near-monopolies and growth slows. This has certainly happened to Cisco since the dot-com boom. Going from $40bn to $80bn in annual revenues will not only take time (roughly a decade at current growth rates), but will limit profit growth. And that is why Cisco is going to reward shareholders with some cash payments, like established companies in their industries do. In a way, the dividend is not only a measure of Cisco's maturity, but also its confidence. ®

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