When Tellabs’ manager of investor relations, Tom Scottino, walked into work one morning last June, he was immediately summoned to a meeting with senior management. They told him they had agreed to acquire Netcore Systems, a Massachusetts start-up, in an all-stock deal valued at about $575 mn. They gave Scottino a stack of documents with all the facts and figures. He was to begin working on it immediately. They wanted this deal tied up smoothly – not like last year’s attempted Ciena acquisition. On the contrary, they planned to close it in less than a week.
Far from being surprised, Scottino had been expecting the company to make a move soon. Tellabs’ annual report had announced the president’s intention of acquiring a corporate partner to bulk up the company’s infrastructure. Scottino jumped into the Netcore deal with his usual enthusiasm.
‘Lots of times investor relations people are the last to hear about these types of things,’ Scottino admits. ‘Usually you’re not brought in until the deal is almost ready to be consummated. That’s part of the investor relations practice, to just sort of roll with the punches, and frankly that’s part of the fun of it.’
Illinois-based Tellabs sells telecommunications products, particularly the big switches that transfer traffic from one telecom service provider to another. Its customers include phone companies and cable operators, with Baby Bells accounting for nearly a third of its total sales. Growing up through a decade of telecom market deregulation, Tellabs learned to compete with the likes of Lucent Technologies, Nortel Networks and Alcatel. By all accounts Tellabs has been a formidable, fast-growing operation. However, it has also been seen to be lacking in certain telecommunication technologies.
Because it was here
Netcore had those technologies. Its unique hybrid product, called Everest, was designed to integrate the communication of voice and data traffic. Everest needed distribution, however, and the company had been seeking a route to the large-scale carriers. It saw its opportunity in Tellabs. John Shaw, Netcore’s vice president of marketing, describes the thinking behind the link up: ‘Here we were with a really nifty technology for that market and here they were with a really good channel into that market, and that was the simple story.’
The fit could not have been better, and partnership made each company look a lot better than it did on its own. Netcore’s product, which was not yet commercially available, had been passed over by a number of carriers, while Tellabs was defending itself against charges that its products were quickly becoming obsolete in such a fast-moving market. ‘The issue was that they were a little too much of the old-world circuit switch versus the new-world packet switch,’ says Lehman Brothers analyst Steve Levy. The merger was an absolute must for both sides.
By last June, major telephone equipment makers had set their sights on next-generation integrated technology. Industry-wide activity was quickly heating up with a flurry of consolidation moves. On the same day that Lucent agreed to pay $900 mn for Netcore rival Nexabit Networks, another competitor, Juniper Networks, launched its IPO.
Lehman Brothers’ Levy claims the Netcore acquisition was a smart move for Tellabs in light of the recent industry developments. Indeed, it was probably the only move at that time. ‘They paid $575 mn for a product that was within six months of generating revenues. The alternatives out there were $8 bn for Juniper or $1 bn for Nexabit, which wasn’t close to the same revenue opportunity.’
Strategic intelligence was just one element of what was to become a textbook smooth deal for Netcore and Tellabs. Once they struck an agreement, the rest fell easily into place.
The Tellabs legal department had become well-practiced at structuring deals, having completed no less than six acquisitions in just four years. The board of directors quickly gave the deal their approval. The company held enough shares, authorized but not yet issued, to complete the transaction. Shareholders, therefore, were not required to vote. To top it all off, Netcore was privately held and its owners gave their unanimous support to the deal. Scottino summarizes the transaction thus: ‘The nature of the deal and the preparation put into it made things pretty straightforward from the IR perspective.’
The companies issued a press release announcing their plans. They claimed the deal would have only a moderate financial effect on Tellabs stock, reducing per-share earnings in the current year by a penny or two, and having either a neutral or slightly additive effect on the following year’s earnings.
After the announcement, the company quickly followed up with a teleconference for financial analysts and institutional holders, which the public could access through a 1-800 number. (Teleconferencing has been one of Tellabs’ specialties: it earned a 1998 Investor Relations magazine US award for best use of conferencing.)
For Netcore management the deal was doubly valuable. It represented a sizeable boost to equity as well as a strategic distribution of its product. Venture firm Matrix Partners, Netcore’s largest outside holder with investments of nearly $8 mn, received about $100 mn in Tellabs stock. Only two months after the announcement, the deal was closed. Suddenly everyone was smiling.
Public courtship
Tellabs management remembered all too well their attempted acquisition of fellow telephone-equipment maker Ciena Corporation just a year earlier. In a much publicized courtship, the companies had engaged in several rounds of negotiation spanning several months. By the fall of 1998 when stockholders were to have voted, the merger looked imminent. Tom Scottino knew at that time that the company would have enough votes to get the deal passed. He had already finished writing the press release to announce the deal’s approval.
Then, 20 minutes before the meeting was due to begin, a call came through from Ciena. ‘They said that AT&T wasn’t going to test their product anymore,’ says Scottino, recalling his shock. ‘This was significant because a large part of Ciena’s 1999 revenues were tied up in the idea that AT&T was testing its product, would standardize on it, and would begin to purchase it. When we got the news we had to call a halt to the whole thing.’
Scottino’s phone was suddenly ringing off the hook. He spent all of his time addressing concerns from shareholders and analysts about the Ciena deal. Though the company initially tried to salvage plans through a new round of negotiations, Ciena’s ability to predict its business going forward was now questionable. The Securities & Exchange Commission added insult to injury by claiming it needed a new proxy that it would take a month for them to review. The deal had become so dilutive that both companies withdrew. They turned inward to begin rebuilding their sagging stocks.
While that episode was a difficult one, Scottino acknowledges that it had an upside: he learned the protocol of investor relations under fire. ‘What I learned was to be prepared as much as possible and to try to anticipate the questions that people will ask. A lot of times you are intimately involved in the company, and that blinds you to the issues that someone outside would have.’ It is important to be candid and straightforward, he says, and to not try to be a ‘super spindoctor.’
Consistent growth
Aside from the temporary Ciena setback, Tellabs has demonstrated consistently good growth for its investors. Its revenues have more than tripled between 1994 and 1998, and its stock has soared nearly 15-fold over the past five years. It beat its own goal of $2 bn in sales by the year 2000, and now it plans to triple that amount by 2003. The plan is appropriately called ‘X3 by O3’.
Tellabs is currently selling a product that facilitates voice and data delivery over cable-TV lines and is working on technology to allow voice transmission over the internet. While voice traffic worldwide grows 7-8 percent annually, internet usage doubles almost every 100 days. More phone calls are being routed using cheaper ‘internet protocol,’ which divvies up spoken words into packets of data and zaps them around a network like e-mail. The company has shown its eagerness to stay on the forefront of technology, even if that means buying what it lacks.
Senior management envisions Tellabs as an independent company that is fully capable of competing with the larger Lucents and Alcatels of the world, despite its significantly smaller size. Scottino boasts that his company matches its more heavyweight rivals by being faster, more nimble and more responsive to customer needs. ‘I’ve always felt that we’ve competed against them using all the classic textbook attributes of a smaller company.’
The question still arises, however: can niche market companies like Tellabs survive industry consolidation without offering the same amount of products as their competitors? Tom Scottino certainly thinks so. ‘There’s going to be room for multiple suppliers,’ he claims, ‘and people who can do better than others will always do well.’
