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Cisco’s Real Estate Valuation Dilemna: How much is enabling face-to-face collaboration worth? April 5, 2010

Posted by Bob Cook in Alternative Workplace Strategies, Financial Planning & Analysis, Real Estate Markets, Silicon Valley.
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Last week the San Jose Mercury News reported that the State of California is moving along on its efforts to sell the last large parcel of the Agnews Development Center property – 86 acres in north San Jose. See “Last of Agnews property up for grabs”.

While other state agencies, county government, local government, and school districts have first dibs on the property, if none of them bite, it’ll be offered to tech company Cisco which has an option, dating back to 1996, to purchase the land for $90 million. If Cisco doesn’t bite, the property will be made available to the public.

Cisco might very well bite. The property is adjacent to its giant, sprawling headquarters campus and would fit Cisco’s modus operandi which has been to consolidate virtually all of its 11,000+ Bay Area employees on this campus. If it thinks it might want to expand its employee population in San Jose at some point in the future, the Agnews site might offer the last chance to expand its campus with contiguous land.

That’s a big “if”, though, because in recent years, Cisco has been expanding its R&D efforts considerably oversees — most notably in Bangalore where it has 6,000 employees and aims to have a total of 10,000 employees in a few years. This overseas expansion has, arguably, been at the expense of growing R&D and other jobs in San Jose, and might be an harbinger of where job growth would be for the company in the future.

Assuming, though, that Cisco wants the land, the issue it needs to deal with is price and bidding strategy. While it has an option to purchase the site at $90 million, the California General Services Administration estimates the value of the land to be only $60 million. If Cisco were to exercise its option, it seems, on the surface, that it would overpay.

But if Cisco doesn’t exercise its option and chooses, instead, to try to be the successful bidder in an open bidding process so it can get the property for something closer to $60 million, it risks not being the successful bidder at all. This is particularly true because price won’t necessarily be the State’s only criteria for selecting the winning bidder. It might, for example, give preference to bids from developers who would convert the site to housing, the promoting of affordable housing being one of the State’s goals.

So that’s going to make Cisco think long and hard about passing on its option to buy. Some might say that the 50% premium it would have to pay above the site’s estimated value is too high, but that estimate of value does not take into account that this property is probably a lot more valuable to Cisco, if it thinks it needs the expansion space, than to anyone else.

As one of the world’s most profitable companies (with net income of $6 billion per year, equal to 17% of revenue), Cisco could, and probably should, look at the value of that land differently than would others. If, in fact, the aggregation of so many employees near one another so as to maximize face-to-face interactions is an important feature of what makes Cisco tick (and it seems that the company’s decision to aggregate so many employees in one place indicates that it does see this as an important feature — and if it wants to provide for future growth — then its valuation of the land should be based on an evaluation of the incremental profit that the company would derive from expanding jobs in San Jose. It should not be based on any of the traditional land appraisal techniques. In fact, this methodology of basing value on what incremental benefit the property would bring to the company would be in line with how companies typically evaluate whether their owner-occupied properties are impaired and should be written down on their balance sheets. Companies typically do a test to see if the cash flows likely to be generated from the enterprise substantiate the property values on their books. If it does, then there’s no write-down — even if the aggregate of all the “market values” (using traditional appraisal techniques) of the properties is less.

Cisco’s high level of profitability would, I guess, easily allow it to justify “overpaying” for the Agnews site. By how much is difficult to judge, but for a company with net income of $6 billion per year, a $30 million premium would not seem too much to me. What Cisco would have to do is think through the value of being able to expand its campus onto contiguous land. Ultimately, that’s a judgement-call on the value of face-to-face communication – a big picture question if there ever was one. Be sure it’s not just a calculation of how much time would be saved in getting people together because they don’t have to drive very far. Instead, the true value would be based on the benefits of the face-to-face meetings – some serendipitous – that just wouldn’t happen at all if folks were not so proximate to one another. These may be just the type of interactions that may be at the core of Cisco’s success.

The irony of all this, of course, is that Cisco makes networking gear that facilitates virtual meetings, remote work, electronic communications, etc. It advertises how it supports “The Human Network” through other-than face-to-face communication (although it’s telepresence product, I suppose, sort of supports face-to-face encounters for those who can afford it.) These analogies aren’t quite on target, but: Cisco’s placing a high value on “face-to-face” would be like McDonalds serving only health food in its company cafeteria, like Nike not allowing employees to exercise at lunchtime, and like the State of Kentucky outlawing smoking.

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