Seven months after announcing a $660 million deal to buy optical component maker Luxtera, Cisco Systems (CSCO) has inked an optics deal nearly four times as large.
The networking giant is spending $2.6 billion in cash to buy Acacia Communications (ACIA) , a developer of modules, components and digital signal processors (DSPs) for optical subsystems within switches, routers and optical networking gear. The deal carries a 46% premium to Acacia's share- price and is expected to close during the second half of Cisco's fiscal 2020, which ends in July 2020.
Here are some initial thoughts on the deal:
1. Cisco's Acquisitions Drive Home the Value of Optics as a Differentiator
As the amount of network traffic within cloud data centers keeps growing -- both due to data moving between end-user devices and data center servers, and due to data moving between servers within the same data center -- network connection speeds are rising in tandem. Servers that may have previously had 10 Gbps optical connections are sporting 25 Gbps connections, while the switches that they interface with are going from having 40-gig connections to 100-gig connections. And within the network core and between data centers, 100-gig connections are starting to give way to 200-gig and 400-gig connections.
Together with the more gradual shift to higher connection speeds in telco networks, this trend is driving demand for more powerful optical transceiver modules in many different parts of a network. And as Acacia has often noted, addressing this demand while meeting its customers' size and power consumption requirements isn't easy to pull off.
During a conference call held to discuss the Acacia acquisition, Cisco exec Bill Gartner noted the purchase of Luxtera, which has developed optical transceivers relying on silicon photonics, helps his company better address demand for 100-gig and 400-gig optical connections within data centers, and that the Acacia deal does the same for longer-distance connections -- whether between data centers or on metro and long-haul telecom network routes.
2. Cisco Sees Acacia's Technology Playing Into Industry Trends
Gartner also argued that Acacia helps Cisco address an ongoing shift within data center and telecom networks from the use of standalone optical networking boxes (referred to as "chassis-based solutions") to pluggable, high-speed modules that go inside of switches and routers. While standalone optical boxes (provided by the likes of Infinera (INFN) and Ciena, as well as Cisco itself) will still be needed for connections spanning longer distances, pluggable optics are getting the job done at shorter distances, and in doing so reducing network costs and complexity.
Acacia has mentioned in the past that modules supporting the new 400ZR standard for high-speed interconnects between data centers, such as its powerful AC1200 module, will help drive this shift towards pluggables. Like other Acacia modules, the AC1200 relies on proprietary chips -- both a DSP for signal processing and a silicon photonic integrated circuit (PIC) for optical functions.
3. The Deal Might Help Cisco Make Greater Cloud Inroads
In addition to networking equipment OEMs such as Cisco, Acacia's customer base includes cloud giants running massive hyperscale data centers and accounting for a steadily-rising percentage of IT hardware spending. Microsoft (MSFT) and Facebook (FB) are known to be two of these clients.
Acacia's exposure to the proverbial hyperscalers has to appeal to Cisco, given that these companies (on the whole) rely much less on Cisco's switches and routers than traditional enterprises; many rely heavily on home-grown hardware designs, and some are also major buyers of Arista Networks' (ANET) switches. Though Cisco does have some high-profile cloud engagements, for now its sales to service providers still depend far more on telcos and pay-TV providers.
4. Cisco Insists It Will Continue Supporting Acacia's Other OEM Clients
In 2018, Acacia sold its products to 30-plus customers and obtained 52% of its revenue from three Cisco rivals -- ZTE, Infinera and ADVA. Cisco accounted for just 14% of Acacia's sales.
When asked about whether will continue selling Acacia's products to such firms in the future, Gartner noted his company already sells optics to rival hardware makers, and deemed the Acacia purchase "a natural progression" of this strategy. Nonetheless, it wouldn't be surprising if some of the Cisco rivals currently buying from Acacia tried to lower their dependence on the company following the acquisition's closing.
5. More Optical M&A Could Be On Tap
Optical component/module suppliers Applied Optoelectronics (AAOI) , NeoPhotonics (NPTN) and Inphi (IPHI) are all up sharply in response to the Cisco-Acacia deal. Macom Technology Solutions (MTSI) , a more diversified telecom chip and component supplier, is also posting big gains.
As I mentioned in a column about potential chip M&A targets that was written shortly before news of the Cisco-Acacia deal broke, the optical component/module space looks ripe for further M&A activity provided that trade tensions (and with them, worries about Chinese regulatory approval for deals) continue easing.
Such dealmaking might be driven not only by attempts from Cisco rivals to respond to the Acacia and Luxtera deals by making their own optical purchases, but by the industry's need for additional consolidation.
