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The Downside of Acquisitions

Acquisitions are never completely risk-free. The biggest challenges are usually product line integration, operations integration, and the risks inherent in entering new markets.

Another concern with an acquisition strategy is the dilutive effect it can have on earnings per share. For example, the total number of Cisco shares outstanding increased by 100 million (almost 20%) from 1992 to 1996, and the StrataCom purchase was paid for with 80 million shares. Although this is not necessarily a negative, it's something to monitor, since a larger number of shares outstanding often dilutes individual shareholder value over time. When a company has an aggressive acquisition strategy based entirely on stock for all transactions, the dilutive effect for existing shareholders is often acute, and the company often will never recover. Cisco continues to be fortunate in that the stock acquisitions have over time boosted the stock price, helped along of course with strong financial performance. Cisco's current situation in 2001 shows a company still capable of making acquisitions on stock, yet the multiple they have paid in the past for public companies (on average, 30X revenue) will undoubtedly decrease (25X or even 20X revenue) to guard against dilutive effects of stock-only transactions driven by purchasing public companies at higher multiples.

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