INTRODUCTION
On September 21, 2023, Cisco announced a definitive agreement to acquire Splunk, the cybersecurity and observability leader, for $157 per share in a $28 billion all-cash deal.
The deal in the cybersecurity market, echoing the industry trend of consolidation, signifies a mutually advantageous collaboration for both firms: Cisco confirms its commitment to expanding its threat prediction and prevention business, steering away from conventional cybersecurity methods, while Splunk expects to gain better visibility on the back of strong integration capabilities with Cisco’s renowned products.
Together, the companies aim to establish a global leader in security and observability, leveraging the potential of data and AI to achieve outstanding customer outcomes and drive industry transformation. A combination of strong commitment to innovation and delivering world-class customer experience is the vision that both parties share and that will drive the post-merger integration.
COMPANIES OVERVIEW
Cisco Systems Inc.
Founded by Leonard Bosack and Sandy Lerner in 1984, and headquartered in San Jose, California, Cisco Systems is a global leader specializing in networking and communication technologies. With the mission to develop a more efficient way to connect computer networks, the company provides end-to-end networking solutions for businesses of all sizes. Listed on the NASDAQ stock exchange since 1990, the company currently has a market capitalization of $214bn (as of Nov-14 2023) making it part of the 10 largest technology company in the United States by market cap. As of July, 2023, Cisco had approximately 84,900 employees, of which 47.6% based in the United States.
The company offers a comprehensive suite of networking hardware, including routers, switches, and wireless solutions as well as cloud services to support organizations in their digital transformation and software applications to protect networks and data from evolving threats. With operations primarily driving revenue in the Americas (59%) and EMEA (27%), Cisco Systems has experienced a consistent upward trend in its financial performance. Over the last three years, revenues have displayed steady growth at a CAGR of 8%, reaching $57bn in FY 2023.
Over the course of its history, the company has consistently implemented a growth strategy through acquisition. As of now, the company has acquired 190 companies that serve to enhance its market share and facilitate entry into new product markets. With the increasing importance of cybersecurity, the company has lately shifted focus towards including a portfolio of security solutions for network observability. The announced acquisition of Splunk perfectly fits within this paradigm.
Splunk Inc.
Founded by Michael Baum, Rob Das, and Erik Swan in 2003, and headquartered in San Francisco, California, Splunk is a leading technology company specializing in data analytics and operational intelligence solutions. The company originated from the realization that conventional methodologies for analyzing machine-generated data proved to be insufficient.
Listed on the NASDAQ stock exchange since 2012, Splunk offers a range of products and services to a diverse customer base, encompassing small and medium-sized enterprises to large multinational corporations, with more than 90% of the Fortune 100 using its solutions.
The company is known for its core product, Splunk Enterprise, a powerful platform which provides a centralized hub for collecting, searching, monitoring, and analyzing machine-generated data from a variety of sources, including applications, servers, networks, and mobile devices. Splunk has developed Enterprise Security solutions to enable organizations to detect, respond to, and mitigate security threats in real-time for building a stronger cyber defense system. In addition, Splunk Cloud is another widely used product that extends the capabilities of the core platform to the cloud, facilitating scalability and flexibility.
In the second of FY 2024, Splunk reported above-forecast revenues of $911m and improved margins due to a 3% yoy cut in operating expenses. This resulted in an upward review of both top and bottom line for the end of the fiscal year in January 2024, with total revenues expected to reach c. $4bn and operating margin at 21.5% (previously 18.5%).
MARKET OVERVIEW
The strategic acquisition of Splunk by Cisco marks a significant move in the software technology sector, particularly in the realm of cybersecurity and observability. Cisco plans to use Splunk’s analytics capabilities to create a new prediction-based cybersecurity product. The union of Cisco and Splunk is strategically aligned with the evolving challenges in today’s hyperconnected world, where data management, protection and security are key in the current AI-powered landscape.
In the current uncertain macro environment with limited deals in the technology space due to recession fears, notable exceptions include the IPOs of British chip designer Arm and marketing automation firm Klaviyo, signaling signs of activity this quarter. The $200 billion cybersecurity market, growing at an annual rate of 12% and fueled by the surge in endpoint devices from remote work, aligns seamlessly with Cisco’s pursuit of growth and recurring revenues, making this deal a landscape-changing move.
Concurrently with the announcement of the negotiations, Splunk likely assessed cost saving, notably in headcount, evidenced by a 7% reduction as reported in the SEC filing released on November 1st. The tech layoff machine clearly keeps churning.
This transformative deal positions the combined entity as one of the world’s largest software companies, reflecting the industry’s trend towards consolidation. Moreover, the transaction is anticipated to trigger a wave of similar acquisitions by major technology players targeting software vendors with consistent subscription revenue, according to insights from industry experts. This highlights the potential acquisition prospects among Splunk’s peers, including Elastic NV, Datadog, Crowdstrike Holdings, and Dynatrace, by technology conglomerates like Microsoft, Adobe and Oracle. These tech giants are responding to corporate clients’ cost-cutting initiatives, creating opportunities for strategic acquisitions.
The positive outlook for software mergers and acquisitions is a welcome relief for dealmakers, given the 61% decline in technology sector activity, totaling $231.5 billion year-to-date in the first eight months of 2023, according to LSEG data.
Such anticipation for increased competition from technology giants comes in contrast to private equity firms dominating the software sector scene over the past year. The current scenario, where software stocks are trading at historically low valuations, adds to their allure as attractive acquisition targets. On average, software stocks are valued at 5.8 times projected 12-month revenue, marking a 28% decrease from their eight-year historical average, excluding the impact of COVID-19, which temporarily inflated valuations in the sector.
DEAL RATIONALE
Despite the recent quietness of the M&A market, Cisco Systems and Splunk set the record in the software space in 2023. The deal aims to help make organizations more secure and resilient in an AI-powered world and will result in the formation of one of the world’s largest software groups.
This acquisition is just the last of the many that Cisco has performed over the last decade. Splunk’s deal is coherent with Cisco’s strategy of acquiring smaller software companies to boost revenues and access fast-growing markets.
Cisco’s biggest acquisitions over the last 10 years
Cisco will benefit from the deal thanks to Splunk’s heritage in helping organizations enhance their digital resilience by screening large amount of information and finding security threats that could affect their businesses. The agreement will enable Cisco to strengthen its software division, heavily dependent on AI, and expand its range of cybersecurity services. These services include creating tools to safeguard users and digital businesses against data breaches.
The timing of the announcement couldn’t have been better: perfectly in line with the current AI trend, Cisco aim to own a share of this new and profitable market, ensuring tis presence in the upcoming generation of AI-driven software and cybersecurity solutions vis-à-vis big tech competitors on the quest to dominate this evolving landscape.
On top of that, falling tech valuations allowed Cisco to acquire Splunk at a 30% discount compared to its all-time high stock price of $225 recorded in August 2020. The intention to pay $157 per share in cash underscores the company’s commitment to enhancing its capabilities in threat prediction and prevention, moving beyond traditional threat detection and response.
Markets warmly welcomed the announcement, as Splunk’s shares soared by more than 20% in pre-market trading of September 21st after the press release. Looking at the graph, the stock price climbed from $117.85 to $146.64 in just two hours, in reflection of positive feedback from investors.
DEAL STRUCTURE
The merger agreement signed in late September outlines the details of the deal structure: Splunk will merge with and into a vehicle wholly owned by the acquirer, and this newly formed entity will survive the merger as a wholly-owned subsidiary of Cisco. Each share of common stock will be automatically converted into the right to receive $157 in cash, determining an aggregate equity amount of approximately $28bn. Financed with a combination of cash and debt, the total compensation amounts to approximately 13% of Cisco’s market capitalization. The agreed-upon per-share consideration includes a 31% premium over Splunk’s closing share price prior to the announcement, valuing the company at 7x NTM revenues.
The news resulted in weaker market performance for Cisco on account of the premium incorporated in the offer price that slightly strides with current conditions of the tech industry. The investors’ reaction is even more logical if we look at the fact that Splunk’s has gained momentum on the back of the huge interest on AI that characterized 2023, and that has certainly opened important discussions on how this technology will evolve and affect our lives in the medium-to-long term.
The transaction is expected to bring notable benefits to Cisco and become cash flow positive and gross margin accretive in the first fiscal year after closing, while generally contributing to accelerate revenue growth (c. +$4bn annual recurring revenue) and margin expansion thereafter. The merger is projected to be EPS accretive starting in year two and will not affect previously announced share buyback program or dividends.
The transaction, unanimously approved by the boards of both companies, is expected to close by the end of the third quarter of 2024, subject to regulatory approval and customary closing conditions. At closing, Splunk will be effectively delisted from NASDAQ and its president and CEO Gary Steele will join Cisco’s executive team. As the market eagerly awaits the completion of this transformative acquisition, the implications for the technology and cybersecurity landscape are poised to be far-reaching.
Sources: Financial Times, Reuters
Authors: Giulia Duca, Louis Meersman, Marco Lodrini, Ataberk Korkutan
Bocconi Students M&A Circle 
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