(Reuters) - Software maker VMware Inc (VMW.N) said it will acquire privately held Nicira Inc for $1.05 billion in cash to expand its portfolio and establish a leading position in virtualized networks.
The deal, which is VMware's biggest acquisition to date, includes $210 million of assumed unvested equity awards and is expected to close in the second half of 2012.
Nicira, a startup founded in 2007, sells software that lets customers create virtual networks that can operate independently of underlying physical networks in what is called software-defined networking.
The company has raised $50 million from venture capital firms Andreessen-Horowitz, Lightspeed and NEA. Diane Greene, co-founder and former CEO of VMware, has also invested in Nicira.
Ben Horowitz said his firm was Nicira's largest shareholder with an investment of $17.7 million and will be paid in cash for the stake.
"VMware is probably the ideal fit," Horowitz said, adding that there had been plenty of interest in Nicira, which had driven up the price. "Still, in retrospect I think the deal will look cheap," Horowitz said.
The networking market has an overall value of about $37 billion and software-defined networking accounts for only a tiny part of that total. According to research firm IDC software, defined networking will grow to $2 billion by 2016 from $200 million in 2013.
VMware Chief Executive Paul Maritz said, "This acquisition was made because of its strategic value as opposed to its current revenue value."
VMware pioneered server virtualization and now it is poised to the same with virtual networks, said Maritz, who will be succeeded by Chief Operating Officer Pat Gelsinger on Sept 1.
"We see similar forces at work here as we move towards the software-defined data center and we saw tremendous strategic value in being able to claim a position of leadership ...," he said.
In a report on Nicira, ISI group analyst Brian Marshall has said that "they should be able to work with VMware."
"VMware isn't doing anything similar but would naturally be interested in the market due to the potential value unlocked by network virtualization," Marshall said in April.
He added that Nicira could create tens of thousands of virtual networks and would eventually be able to support more than 100,000 virtual networks.
Nicira counts AT&T, eBay and Fidelity investments among its customers.
VMware also reported second-quarter earnings of $296 million, or 68 cents per share, excluding items, compared with $235 million, or 55 cents a share, a year earlier. The 68 cents exceeded the 66 cents a share expected on average by analysts, according to Thomson Reuters I/B/E/S.
The company reported last week that second-quarter revenue rose 22 percent from a year earlier to $1.12 billion and that it expects full-year revenue of $4.54 billion to $4.64 billion.
It said it aims to reach revenue of $1.11 billion to $1.15 billion in the third quarter. Analysts on average are expecting $1.14 billion.
VMware had previously forecast sequentially flat revenue in its third quarter but in light of uncertainty over macro conditions in Europe and weaker government spending had lowered its expectations for the third quarter.
Nevertheless, Maritz promised investors that the company's pipeline was strong and that he was confident customers would have excess money to spend at the end of the year making for a strong fourth quarter.
Despite his optimism VMware stock was down 3.7 percent at $86 in after hours trading.
Reporting by Nicola Leske in New York and Sruthi Ramakrishnan in Bangalore; Editing by Steve Orlofsky