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Cisco to acquire Splunk for $28 billion


Vice President: Aaron Cohen

Analysts: Seun Adeleye, Leonardo Bassino, Fynn Hirrlinger, Manav Sood


Deal overview


Acquirer – Cisco Systems

Acquiree – Splunk

Deal size – $28 billion

Sell side advisors – Qatalyst Partners; Morgan Stanley & Co. LLC; Skadden, Arps, Slate, Meagher & Flom LLP

Buy side advisors – Tidal Partners LLC; Simpson Thatcher & Bartlett LLP; Cravath, Swaine & Moore LLP

Introduction


Cisco Systems (NASDAQ: CSCO) has announced its landmark acquisition of Splunk (NASDAQ: SPLK) in a cash deal valued at $28 billion, representing Cisco's largest-ever acquisition (Malik, Soni, & Vinn, 2023). This strategic move signifies Cisco's commitment to bolstering its software business and capitalizing on the thriving artificial intelligence (AI) landscape. The acquisition price of $157 per share in cash reflects a 31% premium over Splunk's recent closing price (Malik, Soni, & Vinn, 2023). This transaction allows Cisco to diversify away from its networking equipment business, which has faced challenges due to supply chain disruptions and post-pandemic demand fluctuations. Splunk, renowned for data observability, provides critical solutions for system monitoring, cybersecurity risk identification, and threat mitigation. Operating on a subscription-based model, Splunk serves a wide-ranging customer base, including global giants like Coca-Cola, Intel, and Porsche (Malik, Soni, & Vinn, 2023). The deal is expected to accelerate revenue growth and gross margin expansion at Cisco, with positive cash flow projected in the first fiscal year post-closure and non-GAAP earnings accretion anticipated in year two (Cisco, 2023). Cisco's CEO, Chuck Robbins, highlights the strategic importance of merging Cisco's capabilities with Splunk's technology to create the next generation of AI-enabled security and observability solutions. The goal is to enhance the security and digital resilience of organizations of all sizes (Goswami, 2023).


The acquisition is set to close by Q3 2024, subject to regulatory approvals and customary closing conditions (Goswami, 2023). In the event the deal doesn't proceed, Cisco will pay Splunk a termination fee of $1.48 billion. Cisco's previous significant acquisitions include NDS for $5 billion in 2012 and AppDynamics Inc. for around $3.7 billion in 2017. However, the Splunk acquisition marks a pivotal milestone, underlining Cisco's commitment to technological innovation and leadership in AI-enabled security. Both Cisco and Splunk will address potential antitrust concerns, but they express confidence that the transaction won't impede competition (Cisco, 2023). The long-standing partnership and shared values between the companies bode well for a smooth integration process and the formation of a powerful global security and observability leader (Malik, Soni, & Vinn, 2023).


In summary, Cisco's acquisition of Splunk is a transformative move that positions Cisco as a dominant player in AI-driven security solutions while diversifying its revenue streams and expanding its presence in the software and cybersecurity domains.

Business overview

Splunk


Splunk, Inc. is a San Francisco-based software company specializing in providing real-time operational intelligence through the utilization of machine data. Founded in October 2003 by Erik M. Swan, Michael J. Baum, and Robin K. Das, Splunk has been at the forefront of helping organizations harness the value of their machine-generated data. The core of Splunk's software platform lies in its ability to collect and index vast amounts of data, regardless of format or source, enabling users to perform real-time searches, correlations, analysis, monitoring, and reporting. This data encompasses information generated by software applications, IT infrastructure, electronic devices, and various systems used by organizations. Splunk's machine data originates from a diverse range of sources, including application log files, call detail records, user website interactions, system configuration files, and more, resulting from both machine-to-machine and human-to-machine interactions.


Over the last two decades, Splunk has evolved significantly to meet the increasing demands of the digital era. Holding over 1,100 patents and fostering a culture of innovation, the company has continually stayed ahead of its customers' needs (Splunk, 2023). Today, some of the world's largest and most complex organizations rely on Splunk to ensure the security and reliability of their mission-critical systems. Splunk's primary mission is to create a safer and more resilient digital world. Every day, the company works towards this goal by assisting security, IT, and DevOps teams in maintaining the security and functionality of their organizations' digital systems. Resilient digital systems empower organizations to adapt, innovate, and deliver for their customers in an ever-evolving landscape. (Forbes, 2023)


Cisco


Cisco Systems, Inc., founded in 1984 by Stanford University computer scientists, is a global tech leader renowned for its dominance in Internet networking. Over two decades, Cisco has shaped the Internet, integrating it seamlessly into diverse sectors, democratizing information access. The company's innovative hardware, software, and services empower individuals, organizations, and nations worldwide. Cisco's extensive portfolio includes pioneering work in routing and switching, with cutting-edge Internet Protocol (IP)-based networking technologies at the forefront. Routers and switches from Cisco establish and maintain robust, scalable networks. Their commitment to innovation extends across domains like home networking, IP telephony, optical networking, security, storage area networking, and wireless tech. Beyond core technologies, Cisco offers a comprehensive suite of products and services catering to diverse clientele, from large enterprises and commercial businesses to service providers and consumers. Hardware solutions, including routers, switches, and security appliances, meet industry-specific needs. Software solutions encompass unified communications, network security, video, virtualization, and cloud computing, facilitating efficient, secure digital operations. Cisco extends its services to include technical support and advanced services, enhancing technology investments.


Cisco operates on a foundation of core values emphasizing customer focus and corporate social responsibility, actively participating in global educational, community, and philanthropic initiatives, contributing to societal well-being and technological progress. With a global presence through sales offices and development centers, Cisco serves clients worldwide. Their mission revolves around making the Internet work securely and efficiently, facilitating connections among people and businesses, unlocking digital opportunities. Cisco, with a rich history of innovation and global influence, remains a trailblazer in technological advancement, propelling networking and beyond. (Cisco, 2023)


Valuation

Discounted Cash Flows Analysis



Comparable Company Analysis


Industry Overview


The Data Networking Equipment and Software Industry operates within the ever-evolving landscape of global communications and information technology. It encompasses a broad spectrum of activities, including designing, manufacturing, and selling Internet Protocol-based networking products and advanced software solutions. This industry, with an estimated annual revenue of $52.6 billion, spans various components such as switching, routing, wireless LAN, IP telephony, and application delivery services, all vital for modern communication networks. (Visually, 2023)


In terms of market share, Cisco Systems, Inc. stands out as a global technology leader, securing a dominant position with a substantial 59% share (Visually, 2023). The company's extensive product range, including routers and switches, plays a crucial role in establishing and maintaining robust, scalable networks for clients worldwide. Splunk, Inc. specializes in the software segment of the industry, focusing on data analytics and operational intelligence. Its groundbreaking software platform collects and indexes vast amounts of data from various sources and formats, enabling users to search, correlate, analyze, monitor, and report on this data in real-time. Splunk's innovative approach has made it a key player in the world of big data and machine data analytics. As organizations increasingly rely on data-driven decision-making, Splunk's contributions have become pivotal in helping security, IT, and DevOps teams keep their digital systems secure and reliable. Both Cisco and Splunk have a global presence, serving clients across the Americas, Europe, the Middle East, Africa, the Asia Pacific, and beyond. Their expansive reach aligns with the industry's international footprint, where seamless communication and data management are crucial in the modern digital era (Cisco, 2023).


The outlook for this industry is highly promising, with expected annual growth of approximately 4.2% (Visually, 2023). This reflects the continuously growing demands for connectivity and communication services in our increasingly interconnected world.

In conclusion, the Data Networking Equipment and Software Industry are on a trajectory of rapid expansion. Technology-driven giants like Cisco and data analytics leaders such as Splunk are at the forefront of this transformation, adapting, innovating, and contributing to the reshaping of the global communications and information technology landscape.


Deal Rationale


Cisco’s revenue streams are heavily dependent on its legacy hardware equipment sales, from routers to modules and WiFi hubs, though this segment is exhibiting slow growth and lower margins relative to software, as well as supply chain disruptions and a slump in demand post Covid-19. Additionally, hardware results in high-value, one-off purchases, whereas software typically follows a licencing or subscription business model. This acquisition represents an opportunity to transition to a recurring revenue model, with projected annualised recurring revenue of $4 billion added to its books.


At present, Cisco maintains expertise in security data, namely network data, identities, emails, web traffic, endpoints, and processes. Splunk’s complementary specialism in data analytics will enhance Cisco’s XDR (extended detection and response), expanding their portfolio of AI end-to-end security and providing observability across hybrid and multi-cloud environments, creating a market-leading platform expected to deliver significant revenue returns.


Splunk can leverage Cisco’s global sales network, increasing the accessibility of its products to new customer bases. The deal will be cash flow positive in the first fiscal year post close, strengthening the combined entity’s strong balance sheet, positioning them well to invest and scale its Generative AI platform. Post-integration, Cisco will become one of the world’s largest software companies.


Cost Synergies


Key cost synergies originate from the integration of operations, namely from optimising IT infrastructure such as data centres, and streamlining distribution networks. Furthermore, R&D collaboration will accelerate the rollout of their Generative AI platform, while simultaneously lowering hardware and software development costs from significant economies of scale.


Risks


Although there are numerous reasons and synergies that can potentially come as a result of this acquisition, it is also important to highlight any risks that could potentially stunt progress. Splunk have had a tough past 2 years – the company lost its CEO and also saw its stock take a massive hit. Despite its obvious value to Cisco, the company isn’t a guaranteed success story once acquired, and coupled with the ongoing business model transition and growing competition at Splunk, challenges may arise in the future when attempting to streamline operations.


Focusing on the acquirer in this deal, Cisco are heavily invested in networking equipment, and this is where most of their revenue is coming from. A challenge for the company in its offering diversification is the sheer amount of the current $50 billion revenue base, which makes it quite complicated to find the subscription revenues in order to renovate the business. The ~30% premium that Cisco paid for Splunk is also a glaringly obvious risk, as if the acquisition doesn’t result in the estimated revenue gains, this premium will be heavily questioned by outsiders and stakeholders. Furthermore, Cisco did not detail any cost savings from the deal, which further disgruntled its shareholders and led to the company losing $10 billion of its value in late September 2023 (2). At the statutory tax rate, the deal would represent about a 3% return on Cisco’s investment – to earn 10%, it would have to earn 4x of its operating profit after-tax.


There has also been concerns that the acquisition may result in some antitrust scrutiny due to an overlap in the security business (3). In spite of the synergistic deal, regulatory concerns will only be a distraction for Cisco and could lead to the company not being able to maximise its capabilities and returns from this deal due to these external issues.


Conclusion


To conclude, it is clear to see when analysing the synergies and deal rationale that Cisco’s acquisition of Splunk is well calculated, as well as being a huge milestone in not only Cisco’s history but the technology space in general. This deal is by far the largest in Cisco’s history and allows them to tap into the cybersecurity market and leverage their international presence. In fact, McKinsey recently projected that damage from cyberattacks will cost around $10.5T annually by 2025, which is a four times increase from 2015 (4). This shows the opportunity that can be capitalised on by Cisco following this acquisition. However, it is important for Cisco to understand that despite Splunk’s sensational positioning within the market, it may not be an easy integration process due to the heavy investments into networking equipment as well as inherent risks from Splunk. Therefore, the corporation must be ready to actively manage this process to fully realise the benefits of the deal.


References

  1. Cisco. (2023). Cisco Overview. https://www.cisco.com/c/dam/global/en_in/assets/pdfs/detailed_fact_sheet.pdf Accessed on 06. October 2023.

  2. Cisco. (21. September 2023). Cisco to Acquire Splunk, to help Make Organizations More Secure and Resilient in an AI-Powered World. https://investor.cisco.com/news/news-details/2023/Cisco-to-Acquire-Splunk-to-Help-Make-Organizations-More-Secure-and-Resilient-in-an-AI-Powered-World/default.aspx Accessed on 06. October 2023.

  3. Forbes. (6. October 2023). Splunk Profile. https://www.forbes.com/companies/splunk/?sh=dfbed7d50996 Accessed on 06. October 2023.

  4. Goswami, R. (21. September 2023). CNBC. Cisco makes largest ever acquisition, buying cybersecurity company Splunk for $28 billion in cash https://www.cnbc.com/2023/09/21/cisco-acquiring-splunk-for-157-a-share-in-cash.html#:~:text=Cisco%20is%20acquiring%20cybersecurity%20software,Cisco%20shares%20closed%20down%204%25. Accessed on 08. October 2023.

  5. Malik, Y., Soni, A., & Vinn, M. (21. September 2023). Reuters. Cisco to buy cybersecurity firm Solunk for 28$ billionhttps://www.reuters.com/markets/deals/cisco-acquire-splunk-28-billion-2023-09-21/ Accessed on 08. October 2023.

  6. Splunk. (2023). Let's build a safer and more resilient digital world. https://www.splunk.com/en_us/about-splunk.html Accessed on 09. October 2023.

  7. Visually. (10. April 2023). Cisco (CSCO) Industry Analysis. https://visual.ly/community/Infographics/business/cisco-csco-industry-analysis Accessed on 09. October 2023.

  8. Spiceworks. (n.d.). Cisco’s Planned $20B Splunk Acquisition: Boom or Bust? https://www.spiceworks.com/tech/it-strategy/news/cisco-splunk-acquisition/ [SeekingAlpha Cisco’s 28bln splunking yields dicey deal.https://www.reuters.com/markets/deals/cisco-acquire-splunk-28-billion-2023-09-21/

  9. Splunk Inc. (2022). Annual Reports | Splunk Inc.https://investors.splunk.com/financial-information/annual-reports.

  10. Factset Database factset.com



The opinions expressed in the reports are those of the members of the Junior IB team and are not affiliated with any university or institution. The financial recommendations provided are for educational purposes only and the Junior IB team takes no responsibility for any losses that may occur from implementing any ideas presented in the reports. The Junior IB team is not authorized to provide investment advice. The information, opinions, and estimates presented in the reports reflect the Junior IB team's judgment at the time of publication and are subject to change without notice. The price, value, and income of any securities or financial instruments mentioned in the reports may fluctuate. The Junior IB team has no business relationship with any of the companies mentioned in the reports and does not receive any compensation for their inclusion.


Copyright © February 2024 | The Junior IB.

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