Cisco-Acacia blurs the optical ecosystem vendor divide

Cisco Systems’ acquisition of Acacia Communications would make it first to market with a 400ZR pluggable coherent interface. So claims Vladimir Kozlov, CEO of LightCounting Market Research. 

“This is the main reason Cisco is doing the deal,” says Kozlov. “It is very important for Cisco to get its core routers with DWDM optics and push network evolution in this direction.” 

Cisco is keen to grow its market share among service providers and lead in the development of software for automating telecom networks centred around routers, he says: “This will be the best way for Cisco to re-energise its optical transport business.”

Tom Williams, Acacia“We are planning to sample [the 400ZR] before the deal closes,” says Tom Williams, vice president for marketing at Acacia. “Our plan is to be first to volume, that is the most important thing.”

The acquisition is expected to be completed in the second half of Cisco’s fiscal year, 2020 (February-July 2020).

We are planning to sample [the 400ZR] before the deal closes

Optical acquisition

Acacia is a merchant supplier of coherent digital signal processors (DSPs). The company also sells photonic integrated circuits (PICs) and coherent optical modules that address data centre interconnect, metro, regional, long-haul and subsea networks. Its latest 1.2-terabit AC1200 - a two optical channel module, each wavelength capable of supporting up to 600 gigabits-per-second - addresses all these applications.

Acacia has enabled system vendors without coherent solutions - firms such as ADVA, Fujitsu and ZTE - to compete with the likes of Ciena, Huawei, Infinera and Nokia that own coherent technology. A successful acquisition will remove the industry’s leading independent supplier of coherent technology. 

It is very important for Cisco to get its core routers with DWDM optics and push network evolution in this direction 

Bill Gartner, senior vice president and general manager, optical systems and optics, Cisco, stressed during last week’s webcast announcing the deal that Cisco will remain committed to Acacia’s business including Acacia’s existing and new customers. 

Cisco will pay $2.6 billion for Acacia. The fee is based on a valuation of $70 per Acacia share, a high purchase price. 

“The $70 price is about 33x the 2020 earnings,” says James Kisner, a financial analyst and contributing consultant at LightCounting. “That’s pretty high for any communication equipment company.” But while the multiple may be high, Acacia is expected to grow earnings 27 percent in 2020. “So 33x isn’t crazy if you believe such expectations,” says Kisner.

The deal will also require the approval of the Chinese regulator given Acacia’s business with vendor ZTE and possibly FiberHome.  

Strategic thinking 

Cisco says that silicon, optics and software are foundational technologies that underpin its success in the marketplace. Buying Acacia with its silicon photonics and coherent expertise will further enhance its silicon and optics portfolios, it says.

The company also points to exponential growth in traffic that is fuelling demand for high-speed network infrastructure. “We believe these dynamics are creating an environment where our customers are needing to increasingly adopt faster speed networking technology - 100-gigabit, 400-gigabit and higher - to support higher bandwidth demands,” says Cisco’s Gartner. 

Cisco sees Acacia as a key asset to be able to address the transition of coherent optics from optical chassis-based systems to pluggable technology.

Even with all three [LightWire, Luxtera and Acacia], we still don’t have the critical mass to go after all of the different silicon photonics opportunities

The move is motivated by data centre players and now service providers wanting to remove the media-converter function such as a transponder or a muxponder. “These have trended in the last few years from line cards that get used by a lot of service providers to pizza boxes that get consumed in data centre content providers,” says Ron Johnson, senior director, optical systems, Cisco. “And now we are seeing service providers starting to use these pizza boxes as well.”

Typically a core router using 100-gigabit grey optics interfaces to a transport box that multiplexes such streams for DWDM transmission. Placing the DWDM optics in a pluggable directly on a router or switch simplifies the task to then aggregating the optical signals for transmission. 

Sterling Perrin, Heavy Reading

Sterling Perrin also highlights the opportunity for pluggable optics, specifically at 400 gigabits.

“This is where the client-side and line-side optics will become the same size, eliminating the faceplate tradeoff problem that dogged IP-over-DWDM for decades,” says Perrin, principal analyst optical networking & transport at Heavy Reading. “We know the cloud/ webscale market will go for integrated pluggables on routers. What’s not known is when and how much this will appeal to traditional telecom operators.” 

Johnson admits that he struggles to predict how quickly pluggables will cannibalise the non-pluggable market because there are complications. One issue is the organisational boundaries within service providers between their packet and transport systems teams.   

One system vendor told Gazettabyte that while pluggables will become an increasingly significant part of the coherent market, it will only account for a third of the total market by 2024, with transport platforms accounting for the rest. 

Industry change

The Cisco-Acacia deal highlights the ongoing consolidation taking place in the optical industry.

The announced deal follows Lumentum’s acquisition of Oclaro, Infinera’s acquisition of Coriant, II-VI’s acquisition of optical component leader Finisar, and Cisco’s acquisition of Luxtera.

At the OFC show in March, Paul Brooks, director of strategy for lab and production at Viavi Solutions, highlighted the change sweeping the industry. He pinpointed three drivers, all beginning with the letter ‘C’: consolidation, commoditisation, and China.

George Notter, an equity analyst at Jefferies, points out in a research note that the purchase highlights two ongoing trends in the optical industry: how the pace of innovation in the optical industry is accelerating, and how bigger and bigger R&D budgets are needed to keep up.

Smaller optical suppliers will struggle to keep up with vendors such as Ciena and Nokia which have sizable R&D budgets, he says.

Vertical integration

The Acacia deal also highlights the trend of how systems vendors are becoming more vertically integrated.  

Ciena stressed its greater vertical integration at the recent launch of its WaveLogic 5 coherent DSP family. Huawei is doing the same, in part to strengthen its technological independence. Infinera has its longstanding indium phosphide PIC technology as well as its in-house coherent DSP that it is using for its latest coherent engine design, the ICE6. The ICE6 will support 800-gigabit wavelengths as will Ciena’s WaveLogic 5.

Ron Johnson, CiscoFor Cisco, being more vertical integrated is important. “There is a pretty significant use of Acacia’s technology in the optical platforms and that has grown over time,” says Johnson. “With the acquisition, we eliminate the margin stack in these situations.” 

In turn, the latest coherent DSPs are implemented in state-of-the-art 7nm CMOS which is costly, as is the development of the algorithmic techniques they implement. And the chip development costs will only rise. Cisco’s deep pockets will help Acacia’s development work in this respect.  

Opportune exit

LightCounting takes another angle on the deal, explaining how Acacia has chosen an opportune moment for exiting. 

Acacia’s growth was hampered by the trade war between the US and China in 2017-2018. The ZTE ban in April 2018 and Huawei ban in May 2019 has impacted the company’s valuation, given that ZTE remains Acacia’a largest customer and that FiberHome may also be using Acacia’s products. “The long term risk associated with doing business in China is a significant problem for the company,” says LightCounting.

In turn, Chinese equipment vendors ZTE and FiberHome are following the example of Huawei in developing semiconductor ICs, optical components and modules to ensure their supply. The Chinese government is also prioritising domestic manufacturing of IC and optical chips, including coherent DSPs, and is investing heavily in start-ups such as Wingcomm.

The merchant market is also limited for Acacia given the dominance of the large optical transport equipment vendors that own coherent technology. 

And longer-term, opportunities such as 400ZR and even 10km-reach 800-gigabit optics also have risk factors in terms of their timing, given the slower-than-expected demand for high-speed optics from the cloud companies in late 2018 and early 2019.

All these issues suggest Acacia is prudent to join forces with Cisco, says LightCounting.

More consolidation?

The deal also raises questions as to the strategy of those system vendors that use third-party coherent DSP technology and even their fate. 

Michael Genovese, managing director of financial analyst firm, MKM Partners, says Cisco's purchase of Acacia has major industry implications, including the potential end of the merchant DSP market. 

The formerly clean delineation between component houses and system vendors has started to blur

“Merchant DSP has allowed Tier 2 and Tier 3 optical systems vendors to survive, so the potential implications are very meaningful,” he says.

Equally, MKM Partners views the acquisition as a positive development for the few large optical systems companies that make their own DSPs: “The reason is that the Tier 2 and Tier 3 vendors are likely to be severely weakened, and the overall industry structure should improve in favour of the large leaders.”

Others view Acacia becoming part of Cisco less bleakly.  

ADVA says such a development is to be expected. “As the world becomes more open and disaggregated, it is only normal and necessary that the supplier-customer relationships in our ecosystem evolve,” says Stephan Rettenberger, senior vice president, marketing and investor relations at ADVA. “The formerly clean delineation between component houses and system vendors has started to blur.”

Vladimir Kozlov, LightCountingRettenberger points out that with companies such as NEL and Inphi, there are still merchant DSP experts supplying the market.

Kozlov also expects the merchant DSP market to recover: “Inphi is committed to it, NEL may get more business, and new vendors may enter including start-ups like Wingcomm.”

Cisco intends to run Acacia as a component business unit and will continue to sell to all equipment makers, says ADVA’s Rettenberger, while Ciena’s Optical Microsystems unit is making its WaveLogic coherent DSPs and module technologies available to the wider market. 

“We at ADVA also run an in-house component team to be more vertically integrated and differentiated at a systems level,” says Rettenberger.

That said, system vendors that work closely with Acacia, share their upcoming systems designs and are privy to Acacia’s coherent product roadmap may have reservations working with Cisco post-deal. “I think we have to assure Acacia’s customers that their information will be protected; that is critical,” says Johnson.

Genovese also questions whether long-term Cisco will support Acacia’s customers. “These optical components companies [that Cisco has acquired] tend to disappear inside of Cisco and become features on Cisco products, rather than stay ongoing merchant optical component vendors,” says Genovese in a research note. 

Johnson counters by pointing out how Acacia’s strong and open culture underpins its success. “Spending this type of money and disrupting that, and not allowing them to execute as they have; that would be a really bad thing for Cisco to do,” he says. 

Acquisition history

The announced deal is Cisco’s second significant optical move in recent months after completing the acquisition of silicon photonics module maker, Luxtera, in February.

Cisco has been down a similar acquisition path before, acquiring coherent technology firm CoreOptics and silicon photonics player, LightWire. But while the acquisitions have served Cisco - LightWire enabled Cisco to come to market with its 100-gigabit CPAK to feed its switch ASIC one year ahead of the competition, while CoreOptics enabled Cisco to have its own early-generation coherent DSPs - the acquisitions no longer serve all Cisco’s needs. 

Which is why, with the growing importance of high-speed optics and silicon photonics within the data centre, and the move of coherent optics from chassis-based platforms to pluggables, Cisco is reopening its chequebook.

According to Johnson, Cisco’s LightWire team has not been focused on making products since the CPAK but rather has been building a library of capabilities that will be used to build products. 

“What they have been doing is a series of design experiments to prove out different functions of the optics, specifically grey optics, to go after the promise of silicon photonics,” he says. This includes wafer-scale integration and wafer-scale testing. When LightWire was acquired, these aspects of silicon photonics were not developed.

On completion of the deal, Cisco can couple its own LightWire and Luxtera silicon photonics expertise with Acacia’s.

“Even with all three, we still don’t have the critical mass to go after all of the different silicon photonics opportunities,” says Johnson. “In almost every piece of work that we define and go after, from a requirements perspective and a market perspective, the confining thing is the resource we have to make it all happen.”

Ideally, Cisco would have invested in its LightWire and CoreOptics acquisition and achieved all of the success that Acacia has had without having to invest $2.6 billion, admits Johnson.

“We fell behind with the DSP technology,” he says. And while Cisco could have invested much more to try and outpace the likes of Acacia and Ciena, he doubts it would have been successful.  

Meanwhile, Acacia has been able to engage the broader industry and make products that fit more applications: “Cisco and all of Acacia’s customers have benefitted from that,” says Johnson.

Now, Cisco wants to more exclusively benefit from Acacia and is willing to spend big to do so.