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Why Cisco Systems Spent $1.9 Billion on BroadSoft

Cisco (NASDAQ: CSCO) recently announced that it will acquire BroadSoft (NASDAQ: BSFT) -- a cloud-based PBX (private branch exchange), unified communications, team collaboration, and contact center services provider -- for $1.9 billion. BroadSoft initially put itself up for sale in late August.

BroadSoft's software provides integrated mobile, video, voice, and other types of digital communication to service providers and enterprise customers. The acquisition should strengthen Cisco's oft-overlooked collaboration business, which offers similar services.

Image source: Getty Images.

A closer look at Cisco's collaboration business

Cisco's collaboration business features services like Spark, a cloud-based platform for messages, meetings, and calls which it launched in late 2015, and WebEx, an older platform for online meetings and customer support which it acquired in 2007.

Other notable acquisitions which beefed up its collaboration unit include Acano Limited, Tropo, Assemblage, Collaborate.com, Versly, Tandberg, and Postpath. Cisco bundled all these collaboration services -- along with other software products (like security software and firewalls) -- with its networking hardware. The idea was that as market commoditization throttled sales of its routers and switches, Cisco could boost its revenue per customer by offering additional software as add-on services.

These bundles were also generally good value propositions for enterprise customers, who would need to pay more if they bought the hardware and software services separately. This widened Cisco's moat against its potential rivals in the networking hardware space.

How fast is Cisco's collaboration business growing?

The enterprise collaboration market could grow from $26.7 billion to $49.5 billion between 2016 and 2021, according to research firm Markets and Markets. That sounds like a great growth opportunity for Cisco, but its collaboration business hasn't really kept pace with those bullish forecasts.

Cisco's collaboration revenues, which accounted for 9% of its top line, actually fell 2% to $4.28 billion in fiscal 2017. Cisco attributed that decline to soft demand for Unified Communications Endpoints (the gateways which handle network communications) offsetting the growth of cloud-based conferencing solutions like WebEx and Spark.

As a result, the collaboration business didn't offset Cisco's 5% drop in switching and 4% decline in routing revenues last year. Revenue from those two aging businesses still accounted for 45% of Cisco's top line. To reduce the weight of those two businesses, Cisco needs to keep gobbling up smaller players like BroadSoft.

The only two businesses which posted positive growth last year -- wireless and security -- also didn't offset the weakness of Cisco's older hardware businesses, and its total revenue fell 2% for the year. Analysts expect Cisco's revenue to remain roughly flat this year, but for its earnings (lifted by buybacks) to grow 2%.

How much will Broadsoft help Cisco?

Cisco has plenty of cash for additional acquisitions. It generated $12.9 billion in free cash flow over the past 12 months, and finished last quarter with $70.5 billion in cash and equivalents, with $3 billion of that total readily available in the US.

Analysts were expecting BroadSoft's revenue to rise 12% to $382 million this year. That's equivalent to about 9% of Cisco's collaboration revenues last year, so the purchase could help the unit post positive sales growth this year. Broadsoft's earnings were expected to dip 1% this year, but integrating its software with Cisco's should reduce the unit's overall expenses.

However, investors should note that the cloud-based collaboration space is getting increasingly crowded, with rival solutions like Microsoft's (NASDAQ: MSFT) Skype and Amazon's (NASDAQ: AMZN) Chime both targeting the same market. Microsoft and Amazon can respectively leverage their Windows and AWS (Amazon Web Services) user bases to promote their collaboration services as alternatives to Cisco's bundled services.

Plenty of other acquisitions on the way...

The Broadsoft acquisition marks Cisco's 200th acquisition, and its shopping spree won't end anytime soon. Cisco will keep buying high-growth companies to beef up its smaller collaboration, wireless, and security businesses, but it needs to be careful that it doesn't "diworsify" its business as it aggressively diversifies away from routers and switches.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun owns shares of Amazon and Cisco Systems. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.