Why Is Cisco Buying Splunk?

 

Cisco Systems Inc (NASDAQ: CSCO) announced a $28 billion all cash deal to buy cyber security company SplunkSPLK -0.1% last week, marking the networking major’s largest acquisition yet. Splunk is a market leader in security information and event management, analyzing log files, and other data, and using artificial intelligence to help companies minimize the risk of cybersecurity incidents.

Interestingly, Cisco stock has had a Sharpe Ratio of 0.3 since early 2017, lower than 0.6 for the S&P 500 Index over the same period. This compares with the Sharpe of 1.3 for the Trefis Reinforced Value portfolio. Sharpe is a measure of return per unit of risk, and high-performance portfolios can provide the best of both worlds.

As the world becomes more reliant on interconnected computer systems, cyber attacks can disrupt economic activity, sabotage critical infrastructure, and compromise countries’ security. There have been a series of high-profile cyber attacks on businesses in recent quarters, including a notable attack on pay TV major Dish Networks. McKinsey has projected that damage from cyberattacks will cost about $10.5 trillion annually by 2025, a 4x increase from 2015 levels. This is making digital security a more important investment priority for both governments and businesses. Cybersecurity is an area Cisco has been prioritizing for a couple of reasons. Cisco’s growth has cooled a bit in recent years, as information technology spending has shifted from traditional on-premises hardware and networking equipment to more cloud-based services such as Amazon’sAMZN -3.3% AWS. This has made the company focus increasingly on security, which is a natural extension of the company’s networking business. Cisco has a separate reporting segment called End-to-End Security, which consists specifically of security products, with revenue accounting for roughly 7% of total sales last year.

Cisco is paying a roughly 30% premium to Splunk’s market price as of last Wednesday before the deal was announced. This values Splunk at a little over 7x forward revenues, which we believe is a fair multiple considering that Splunk is poised to grow at close to double-digits in the near term, with its margins also picking up. Splunk’s free cash flow profit margin is poised to hit about 22% this year, more than double recent lows. Separately, Cisco has been increasingly pivoting to a recurring revenue model and this deal should help to a large extent, adding roughly $4 billion in subscription-related revenues per year. Cisco also expects the deal to aid cash flows as well as gross margin in the first fiscal year after the close, while it should help boost adjusted earnings per share from the second year of closing. The deal is expected to close about a year from now.

While Cisco stock has reacted negatively, declining by about 4% since the deal was announced, we think Cisco stock is undervalued at current levels — given the longer-term promise of the Splunk deal and the current recovery Cisco is seeing in its core networking business, with supply chain related issues easing. We value CSCO stock at about $59 per share, which is about 13% ahead of the current market price. The stock trades at under 14x consensus earnings for FY’23. See our analysis of Cisco Valuation for a closer look at what’s driving our price estimate for the stock. Also, check out our analysis of Cisco Revenue for more details on the company’s key revenue streams.

Reference: https://www.forbes.com/sites/greatspeculations/2023/09/26/why-is-cisco-buying-splunk/?sh=369796c069e3

AH