On Jan. 24, Cisco (CSCO) announced its intent to acquire privately held AppDynamics for $3.7 billion in cash and assumed equity awards, a hefty premium to the latest (December 2015) valuation of $1.9 billion. The transaction is expected to close in the third quarter of fiscal 2017. Strategically, Cisco continues to gobble up software companies that occupy leading positions in various niches such as security, Internet of Things, collaboration, analytics, and cloud infrastructure.

This acquisition supports our main thesis that Cisco is focused on diversifying its revenue stream away from a heavy reliance on the core networking portfolio. We think AppDynamics will be able to leverage Cisco’s huge customer base and direct salesforce to accelerate top-line growth. We like Cisco’s software-focused acquisition approach as we believe the commoditization of hardware and migration of data center workloads to the cloud represent a long-term threat to the company’s traditional businesses. Our narrow economic moat rating and fair value estimate of $27 per share for Cisco remain unchanged.

Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.