Cisco Goes Top Shelf

While Cisco Systems Inc. (Nasdaq: CSCO) has preferred to keep the details of its involvement with Andiamo Systems Inc. its in-house SAN switch "startup" – as utterly clandestine as possible, it's now having to come clean about how it's funding the project (see Cisco Alters Andiamo Accounting).

Cisco's hand was forced because of post-Enron regulations designed to provide investors with more information about off-balance-sheet investments. I think Cisco was shrouding Andiamo in secrecy because it wanted to keep its competitors (as opposed to its investors) in the dark as much as possible.

But now more of the gato is out of the sacchetto. The upshot: Cisco has clearly been committed to pouring major bucks into this.

For those of you who might have thought Andiamo was a side project, think again. Cisco has made no secret that it expects to reach the No. 1 spot in the Fibre Channel switch market – and quickly. It's now apparent that Cisco is putting its money where its mouth is.

Cisco says it will now account for stock options granted to Andiamo employees as operating expenses. It will take a $200 million to $500 million charge to account for those options for the period between April 2001 and July 2003. It's a variable range, because Cisco is basing the eventual purchase price of Andiamo on a somewhat arcane formula tied to how many Fibre Channel switches it can sell in a three-month period in the next year or so.The key here is that the number is based on future expected sales of Andiamo gear, so Cisco is either pretty confident or pretty deluded about its chances. Either way, it is being forced to ante up on this gamble today instead of next year, when it expects to close the "acquisition" of Andiamo. Those options-related expenses are in addition to the $139 million it's already invested in Andiamo via debt "instruments" – love that accounting lingo! (See Cisco Buys Andiamo and Cisco's Creative Andiamo Options.)

Even on the low side, Andiamo employees stand to make out pretty well – that is, if Cisco meets its expectations. The unit has a headcount of around 300; the value of the options for that 27-month period would average out to at least $650,000 per employee. That's not necessarily dotcom-era largesse. But it shows Cisco will shell out for the Fibre Channel engineering expertise it needs to win in the market.

But just dumping lots of money into a venture doesn't automatically mean it will succeed. Just look at well-backed storage startups like Cereva or Zambeel that blew through millions before crumpling into smoking wrecks (see Cereva Sells Out to EMC, Zambeel Znuffed Out, and Zambeelians Reemerge at StorAD).

Cisco has yet to really earn its stripes in the Fibre Channel market. Yes, it has inked reseller deals with four major storage vendors – EMC Corp. (NYSE: EMC), Hitachi Data Systems (HDS), Hewlett-Packard Co. (NYSE: HPQ), and IBM Corp. (NYSE: IBM) – but there's obviously no guarantee these will result in substantial sales for Cisco (see Cisco Puffs Up Reseller Deals and EMC, Cisco Do the Deed).

And of course, it's probably still true that in the long run, Cisco views IP as the ultimate winner in the SAN space. As Luca Cafeiro, senior VP and general manager of Cisco's switching, voice, and storage technology group, said earlier this year: "Fibre Channel has a lot more potential today... but 18 months, two years from now, I don't know." (See Cisco Knocks 'Nerd Knobs'.)All the same, SAN switch incumbents like Brocade Communications Systems Inc. (Nasdaq: BRCD) and McData Corp. (Nasdaq: MCDTA) should be getting the picture by now that Cisco is not treating Fibre Channel switches merely as a way station.

Curiously, the message may not be getting through to everyone yet. On Brocade's earnings call last week, CEO Greg Reyes had the brass to scoff at the $10 million in SAN switch sales Cisco reported in its most recent quarter: "Ten million dollars seems to be quite disappointing for a multibillion-dollar company."

Reyes may truly believe Brocade can hold its ground. And the company – though hurt by layoffs and the need to digest the recently acquired Rhapsody Networks – will be able to win against Cisco to some extent. But how do you say "He who laughs last, laughs best" in Italian?

— Todd Spangler, US Editor, Byte and Switch