That approach to valuation will increasingly become part of strategic deal-making. Indeed, Carol Levenson, the director of research at New York–based Gimme Credit, concedes that the enormity of last year's PE bids undermines the humor of her joke about public companies banding together defensively. It won't be long, she says, before being a huge public company "offers little or no protection, as size and leverage barriers continue to fall for private-equity deals."

Roy Harris is a senior editor at CFO.

Why Cisco Loves Private Equity
(A CFO.com Exclusive)

Some acquisitive public companies might be worried about the competitive threat from deep-pocketed private-equity players. But not Cisco Systems.

The San Jose-based technology company—whose $6.9 billion acquisition of TV cable-box maker Scientific-Atlanta was one of the top 20 deals of 2005, a year with only 11 deals of $10 billion or more—sees the enormous expansion of merger-and-acquisition activity by private investors as creating collaboration, not competition.

"We’re not a turnaround shop," says Ned Hooper, Cisco’s vice president, corporate business development. "Private equity can do that." And if private buyers play the corporate doctor, taking underperforming companies and applying strict financial discipline to their operations, Cisco would be more than happy to reap the benefit by snapping a target up if it was the right fit.

Cisco, which grew huge primarily by acquiring makers of routers and switches for the Internet, tends to seek smaller targets. "We see new-market entry as a constant business process for us," says Hooper. And the operations it buys "are not initially billion-dollar businesses," he says—until they are combined with one or two more acquisitions in the same field.

Cisco’s deal this week to buy closely held IronPort Systems was one of its bigger plays—costing Cisco about $830 million in cash and stock. Hooper, who spent much of the year-end holiday on the deal, notes that private equity—precisely speaking—wasn’t involved.

"It depends on how you define private equity," he says, noting that IronPort has about $95 million in venture capital backing. While most investors think of private equity as dealing with late-stage start-ups, VCs, strictly defined, are a subset of private equity.

Even though it's somewhat larger than the average Cisco acquisition, messaging-security company IronPort fits the Cisco M&A profile in many ways. IronPort would expand Cisco’s existing security-products line. "Security has been an important business for us," Hooper says, "but messaging security is not a business we're in today. And IronPort is the leader, so it provides a market-leading platform for us to expand in that area."

The purchase of IronPort is expected to close in the third quarter of the current fiscal year, which ends July 29. Cisco expects it will be neutral to fiscal-year earnings on a non-GAAP basis.

The Scientific-Atlanta deal marked a shift for Cisco. "It was the largest deal we've ever done in terms of number of employees and the scale of the business," Hooper says. "It demonstrated our ability to do larger deals," even though its primary function was taking Cisco into a consumer field that it believes is critical to the future. "Scientific-Atlanta is about the transformation that video is causing in the network," the executive says.

Within the M&A framework of concentrating on smaller deals and occasionally plunging into a larger acquisition, Cisco envisions the prospect of partnering with one or more private equity players when a big one comes around. And certainly, according to Hooper, it would consider buying operations that private buyers have put through a restructuring, though that hasn’t happened yet. "Private equity now has a scale and capability to address large companies that are very inefficient," he says. And one of Cisco’s strengths, he says, is identifying "good assets stuck in bad companies." —R.H.

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