A merger between Swedish networking and telecommunications company Ericsson and networking giant Cisco Systems, Inc. (NASDAQ:CSCO) is very unlikely according to JP Morgan analyst Rod Hall who says Ericsson is “not a good fit” for Cisco.
Speculation unwarranted
Speculation of a merger between the two companies has resurfaced recently with Bank of America reportedly saying that the merger “could have benefits”. Ericsson’s share price has rallied since Feb 17 while its call option volumes are experiencing some of their highest levels for close to two years. It is currently trading at 58.40 SEK on the Stockholm Stock Exchange (STO).
But JP Morgan’s Rod Hall is unconvinced. The idea of a merger does not make sense “from a strategic and/or technological perspective.” And most damagingly, the merger would not be profitable as the market thinks with a maximum earnings accretion from the merger of only 10% according to Hall’s analysis. In fact, the percentage could be as low as 4% if no significant synergies are realized between the two companies.
Acquiring Ericsson could even cause Cisco’s margins to fall to 53% from 64%, leading to multiple compression says Hall. Multiple compression is a problematic scenario where a stock trades at a certain multiple and, while earnings may be strong, the stock price stays static (neither rising or falling) so that the P/E ratio is reduced even though the company has no fundamental problems.
What would Cisco gain from the merger then? The answer is new cellular access technology. However, Hall is even dubious about how beneficial this technology would be as he believes that network automation could be implemented without controlling cellular access.
The analyst, who maintained his Cisco hold rating, is ranked #1,130 out of 4,498 Wall Street analysts tracked by TipRanks’ financial accountability engine due to his profit rate of 49% and an average return of 5.8%.
Merger required
Separately top UBS analyst Steven Milunovich reiterated his buy rating with a $37 price target (7.8% upside). Despite his bullish rating, Milunovich stated that the company’s mixed fundamentals and core business competition means that Cisco may need aggressive merger action (although not necessarily with Ericsson) to boost its revenue results.
Cisco is in an acquisition phase as it evolves from its core hardware network business to software in order to offset hardware sales declines, most recently acquiring application management performance platform AppDynamics for $3.7 billion right before AppDynamic’s planned IPO. This followed Cisco’s announcement in August that it was cutting its workforce by 7%.
Consensus outlook
Cisco has a consensus outlook on TipRanks of moderate buy based on analyst ratings in the last 3 months (13 buy, 4 hold, 1 sell) with an average analyst price target of $35.38 representing a 3% upside from the current share price of $34.32.
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