Cisco's purchase of TV box maker either bold or desperate

Networking-equipment giant Cisco Systems - with annual revenue of more than US$25 billion ($35 billion) and a market value of about US$108 billion - has had pockets deep enough to buy just about anyone it wanted to for the past decade or so, but it has deliberately shied away from the mega-deals that other companies have found so appealing (yes, we mean you, Nortel and JDS).

That's not to say Cisco didn't blow its share of dough during the tech bubble, but in most cases it has focused on acquiring smaller companies that could be "folded in" to its existing operations.

With that kind of backdrop, the recent announcement that Cisco was making a takeover bid for Scientific-Atlanta - a maker of TV set-top boxes - made many analysts and investors sit up and take notice. With a value of $6.9 billion, it is one of the largest deals the networking company has done in its history as a public company.

For some, the sheer size of the acquisition raised an inevitable question: Was this a desperate bid for growth by a company whose growth is slowing or a smart move that could help to position Cisco for growth in a new market?

There is plenty of evidence to support both arguments. On the optimistic side, many industry watchers believe the future of television is interactive and digital - digital meaning high-definition TV, but also other content such as internet services, photos and music, and interactive meaning two-way, with email and classifieds and photo-sharing and so on - all using the television as a platform. That future requires a sophisticated interface between the TV and the cable going into it, and that means a smart set-top box of the kind that a company such as Scientific-Atlanta is used to building.

In fact, the company - the second-largest maker of set-top boxes, next to Motorola - already has its foot in the door of such advanced services, with a partnership involving AT&T, which used to be SBC.

The telecom carrier, which is facing pressure from cable companies and voice-over-internet providers, wants to expand into digital entertainment and is testing a service called Lightspeed, which would use its fibre-optic network to provide cable-style entertainment as well as other digital and interactive services.

Cisco supporters say this fits with its move into home networking (through its purchase of Linksys) and it could be the gatekeeper for IPTV (internet protocol television).

So much for the optimistic case. The pessimists see the Scientific-Atlanta purchase as a simple grab for expansion from a company whose sheer size makes it difficult to produce the kind of double-digit growth it did in the past.

What makes the deal even more of a stretch, they say, is that Scientific-Atlanta isn't even growing that quickly: 7 per cent to 10 per cent a year, according to analysts. Although the IPTV and digital interactive services market could be a gigantic money-maker for the company, it remains only a potential future payoff rather than a reality, making it harder to buy Cisco's argument that it is worth spending $6.9 billion for the company.

Cisco chief executive John Chambers sees Scientific-Atlanta becoming a key part of the company's "all-in-one" solution for cable providers and telcos: a single system that combines the functions of a home-network router, a DSL or cable modem for internet access, and a set-top box with TV output, digital inputs and interactive capabilities - plus the gear required to make it all work at the "head-end", or network operations centre of the cable or telecom network. Whether telcos and cable operators will want to rely on a single company for all of those components remains to be seen, however.

Then there's the question of partners. Microsoft, which has been pushing telcos and cable companies to adopt its IPTV software as part of their trials, has been working with Alcatel, which also makes modems and set-top boxes. Cisco says it wants to convince Microsoft to work with it instead. If the two manage to set up a partnership, that could work well provided Microsoft's software manages to capture a big enough chunk of this new market. If telcos and cable companies choose to partner with others instead, such as Google or Yahoo, then Cisco could be left out in the cold. And in the meantime, it will be trying to serve the needs of three separate sets of conflicting customers: satellite providers, cable companies and telecom companies.

In other words, Cisco's big bet has a lot of potential, but it is far from being a slam dunk. In fact, the company may have just bought itself $6.9 billion worth of headaches. Whether those headaches will eventually pay off is a question that investors in Cisco will have to answer for themselves.