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Cisco Goes After Cloud Services With $1 Billion Investment

Late to the party, it may have to buy its way to credibility.

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Networking giant Cisco Systems today placed a big bet on the cloud computing services business, saying it will invest as much as $1 billion to build a “network of clouds” that it will call InterCloud.

Rather that build its own distinct service to compete with the likes of Amazon Web Services or IBM SoftLayer, Cisco said it will deliver the service through a network of partners. The service will be based on Cisco’s Unified Computing System, with its combination of servers, storage and networking aimed at data centers. Partners include Australian telecom services provider Telstra, Allstream in Canada and tech distributor Ingram Micro.

The network of partners would give Cisco the ability to quickly reach the kind of scale needed to offer a global cloud service. Customers would sign up with one partner in one part of the world, and then expand their reach into another by working with a second partner.

“We’re building this for connecting billions of things and tracking trillions of transactions, and that is now how current clouds are built,” Fabio Gori, Cisco’s director of cloud marketing, told Re/code in an interview this morning.

One reason for the different approach is data sovereignty. Many companies have legal requirements that the data they use can’t leave the physical borders of the countries in which they operate. Working with a network of partners that already have a presence in those countries makes that easier. Other cloud companies like AWS and IBM SoftLayer have a relatively small number of data centers that may not be physically located in the relevant countries. “In a lot of cases there is a need to stay within a given geographical area or a country,” Gori said. “We’ll be able to do things that others aren’t able to right now.”

InterCloud will be based on OpenStack, the open source cloud-computing operating system developed at NASA. It will also include a handful of Cisco’s existing applications that have been ported to run in the cloud, including its WebEx virtual meeting application and Meraki, a cloud-based tool for managing Wi-Fi networks.

Cisco is fairly late among its peers to be making moves in this area. Amazon has built is Web Services unit into a computing juggernaut that brings in between $3 billion and $4 billion per year, while IBM’s combined cloud services and applications business was worth $4.4 billion last year. Another Cisco rival, Hewlett-Packard, has a service it calls HP Converged Cloud.

In order to become a credible player, and in order to fill out the portfolio of services it will have to offer, Cisco may have to consider making an acquisition. “It’s good that Cisco is investing, but they are a bit late to the party,” said Patrick Moorhead, head of Moor Insights and Strategy, a boutique research firm. “To be a full service enterprise player, companies are expected to provide a range of cloud services, including public cloud, private cloud and hybrid which combined them both. IBM and HP have spent billions building and buying their services. Cisco has a lot of catching up to do, and it will have to act fast.”

It’s hard to say in that scenario who the more likely targets are because there’s really only one worth considering that’s big enough for Cisco: Rackspace. The Texas-based cloud services provider was early to embrace OpenStack, and it has data center presence in the U.S., U.K. and Australia. Its customers include the Domino’s pizza chain and amusement park company Six Flags.

Cisco has about $47 billion in cash and short-term investments and could easily afford the $6 billion or so it would take to acquire Rackspace, assuming a 30 percent premium over its current price. Rackspace shares have recently fallen by more than 40 percent from a recent high after an unexpected management shake-up. Even so, it may be overvalued at its current price, trading at more than 53 times the prior year’s earnings.

Other cloud services players are either too small to be meaningful for a company of Cisco’s size or have already been acquired by larger companies. IBM spent about $2 billion to acquire SoftLayer last year. Verizon spent $1.4 billion to acquire Terremark in 2011. That same year, CenturyLink spent about $2.5 billion to acquire Saavis.

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