Editor’s note: Cisco made headline news worldwide Wednesday with the announcement it was buying pre-IPO cloud tech firm AppDynamics for $3.7 billion. That’s nearly double AppDynamics’ valuation. So why make such an expensive deal? Here’s an analysis for our Insiders.

HAMPTON, N.H. – Cisco scooped up AppDynamics hours before IPO in the industry’s latest cloud brokerage acquisition

And AppDynamics looks to Cisco’s large cash position as an alternative to an IPO just in the nick of time, benefitting both companies and customers

Cisco announced its intent to acquire San Francisco-based cloud pure play AppDynamics Jan. 24, just ahead of AppDynamics’ planned initial public offering (IPO) Jan. 25. Cisco plans to buy the company for $3.7 billion, nearly double that of the company’s latest valuation of $1.9 billion.

[VIDEO: Watch a tutorial about AppDynamics’ technology at https://www.youtube.com/watch?v=At17jFbpn00 ]

From a strategic perspective for Cisco, this purchase represents its goal to derive a higher percentage of revenue from recurring software and services sales as the network hardware market is forecasted to contract over the long term. Recurring software and services revenue accounted for 29% of Cisco’s total revenue in 3Q16, 9% of which was generated from software subscriptions.

From a revenue generation standpoint, AppDynamics has disclosed its annual revenues for fiscal years of $23.6 million for the year ended Jan. 31, 2014; $81.9 million for the year ended Jan. 31, 2015; and $150.6 million for the year ended Jan. 31, 2016. Cisco’s substantial cash on hand enables it to swiftly make both small and notable acquisitions such as this one, a strategy it has used to inorganically buoy revenue and overall financial performance in the face of volatile network hardware sales.

We believe AppDynamics delayed its IPO, which was originally projected for the fall of 2016, due to stock market fluctuations amid the U.S. presidential elections as well as the company needing more time to shop around for a buyer. Particularly one that understands the benefits of acquiring such a firm with cloud-based software and services despite its characteristic high-growth, but high-cost business model that Wall Street is less enthusiastic about.

It is likely Cisco and many other larger IT vendors had been interested in the cloud startup for some time, but the IPO accelerated the time line, which gave AppDynamics the ability to bring the price higher since it was already slated for IPO.

Acquiring AppDynamics underscores Cisco’s goal to grow its value proposition from not just that of a network infrastructure supplier, but to include domain expertise in application performance monitoring (APM) and management. Also, this acquisition will help Cisco provide a lens into how successfully customers’ applications and infrastructures are working together and how to best utilize both, ultimately driving opportunities around the to-be-acquired solution as well as lead into more infrastructure sales.

The purchase is a natural extension of Cisco’s Application Centric Infrastructure (ACI), the company’s flagship SDN framework. While ACI is integrated within Cisco’s Nexus switches, it remains to be seen whether the company will similarly bake in AppDynamics’ solution with hardware, or offer the software as a standalone offering. Either way, pushing further up the software stack moves Cisco from its traditional networking core competency, a risky, but necessary path to redefine its role in the market.

We expect this arrangement will also drive professional services opportunities for Cisco Services as clients look to vendors more often, particularly Cisco and AppDynamics, for tools to monitor and manage applications running on infrastructure. This drives increased demand for services, particularly advisory services around architecture design and planning as well as implementation services that the combined Cisco and AppDynamics’ team of 1,200 will be better equipped to capitalize on. This also provides more opportunity for Cisco’s partners that tend to jointly go to market with the IT giant in consulting and systems integration engagements.

Additionally, one area of growth opportunity can be security services related to Internet of Things (IoT) and Cisco’s recently launched Security Services for Digital Transformation, part of the Cisco Security Advisory Services portfolio. It positions the company to capture transformative opportunities with clients by integrating its consult-build-run services and products into comprehensive solutions.

Finally, AppDynamics promises to contribute to Cisco’s IoT System, its broad collection of IoT capabilities available to customers through its pillars of Network Connectivity, Fog Computing, Security, Data Analytics, Management and Automation and Application Enablement. TBR expects the AppDynamics Platform to provide support as Cisco helps customers extend from IoT proof-of-concept projects to broad IoT deployment, across a range of business functions. One path might involve migrating from leveraging IoT sensors and data to implement a proactive maintenance program at one manufacturing plant to an entire global network of plants, or from proactive maintenance to manufacturing and supply chain optimization.

Cloud brokerage-related acquisitions are the new cloud vendor investment

In addition to the revenue and brand recognition Cisco will gain because of this acquisition, it will make a splash in the cloud brokerage market where AppDynamics is a well-known player. Over the past year and a half, cloud brokerage and cloud integration-related acquisitions have become commonplace, with cloud and IT services giants like IBM, Accenture, Wipro and many others picking up niche startups with cloud and software IP that address customer pain points around cloud sprawl to quickly establish toe holds in this emerging cloud market.

The week of Jan. 23 alone, there have been three notable cloud brokerage-related acquisitions: On Jan. 23, HPE announced its intent to purchase CloudCruiser; Cisco announced plans to acquire AppDynamics on Jan. 24; and on Jan. 25, Accenture acquired solid serVision.

TBR, in a November 2016 report, Pure play acquisitions plentiful for quick picking, discussed the growing skills gap enterprises are facing around cloud brokerage, particularly the monitoring, provisioning and managing of cloud applications and infrastructure. As ad hoc, departmental and often siloed cloud adoption proliferates in the enterprise, there are often many cloud assets being paid for yet underutilized; and as such, IT departments are taking on the role of an internal service broker to their lines of business to help optimize utilization and rein in spending.

Tools and platforms like those that AppDynamics offers, particularly around APM, help organizations calculate departmental spend to ascertain what their entire business is spending on cloud purchases and to ultimately chargeback to each department based on usage to appease departmental budget concerns. As such, we expect to see continued consolidation in the cloud brokerage market as the market emerges such that large cloud vendors obtain the software IP and expertise these startups provide, while the startups that once struggled with resources and scale have the backing of larger, multinational organizations to expand their routes to market.