Investors Deprecate AFC-Tellabs Deal

The head scratching has officially started now that, after weeks of rumors and big hints, Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) has finally decided to buy Advanced Fibre Communications Inc. (AFC) (Nasdaq: AFCI). (See Tellabs Buys AFC for $1.9 Billion.)

AFC's shares got a lift and Tellabs shares took a beating as investors booed the deal from the cheap seats. Shares of Tellabs fell $1.24 (13.49%) to $7.95 in trading on Thursday, while AFC's shares hopped $2.13 (12.66%) to $18.96.

As part of the proposed acquisition, AFC stockholders will get 1.55 shares of Tellabs common stock and $7.00 in cash for each AFC share. Based on Tellabs' closing price on May 19, each AFC share would be valued at $21.24, giving the deal a total value of $1.9 billion.

But Thursday's investor activity had the effect of wiping away much of the deal's potential value, giving Tellabs a steal where it would have had a bargain. Based on Tellabs' closing price on Thursday, each AFC share would fetch $19.32, making the deal worth about $1.7 billion.

The running commentary from investors and analysts on the Thursday conference call following the announcement was mostly disappointment that AFC decided to sell for a relatively modest price after having finally reached a significant point in its development. The company secured the largest nation's largest RBOC -- Verizon Communications Inc. (NYSE: VZ) -- as a customer; and the service that showcases AFC's technology, fiber-to-the-premises (FTTP), is just getting started (see Verizon Flaunts Fiber Plan and Verizon's FTTP Demo Helps AFC).

John Schofield, chairman, president and CEO of AFC, doesn't see it that way. "It should not be viewed as a sellout at all. It should be view as an opportune time that just happened to appear right now."

But why should a sale happen at all? Morgan Keegan & Company Inc. analyst Simon Leopold recalls that in the 1990s, Tellabs succeeded as a relatively small company that sold its gear to RBOCs on its own. Why can't AFC evolve to do the same thing?

AFC, after all, has the big win with Verizon and an installed base at BellSouth Corp. (NYSE: BLS). "For years, Advanced Fibre strove to penetrate the RBOC accounts, and now that it has, it must grow to meet these customers' needs," Leopold wrote in a May 17 research note.

Indeed, some are suggesting that AFC's move is out of desperation rather than opportunity. The company is having a tough time supporting a customer as large as Verizon, according to analysts and fund managers close to AFC.

AFC has already missed one deadline with Verizon -- a gaffe that cost it $2 million in cash. Over time, matching Verizon's rigorous development, testing, and deployment schedule might have distracted AFC from its other customers (see AFC Fesses Up, Defenders Pipe Up).

"Be careful what you wish for. You might get it," says Leopold.

Schofield implied during the call that there was some urgency to sell, though he didn't specifically refer to difficulty handling Verizon: "We are on a roll, and it's that roll that we're on that causes us to feel the need to take advantage of this opportunity right now." (See AFC Chief Says Sale Makes Sense.)

The two companies say the deal is extremely complementary, especially given that their product lines don't overlap. Tellabs gets a foothold in the access market, which is growing faster than its crossconnect sales and other businesses. And the deal gives AFC an entrée into international markets, not to mention the sales and support staff to handle customers such as Verizon (see Tellabs Angling for Access – and AFC).

Some investors and analysts, however, point out that the combination of Tellabs and AFC isn't that interesting. "We believe the combination of AFC's access products with Tellabs' switching makes sense from a strategic standpoint, but believe the synergies of the deal are not compelling enough to justify the merger," writes J.P. Morgan Chase & Co. analyst Ehud Gelblum, in a note published Thursday.

"Tellabs has also had a spotty track record integrating large acquisitions as products from Vivace and Ocular have yet to contribute meaningfully." (See Tellabs Nabs Ocular and Tellabs Snags Vivace for $135M.)

Another investor concern is that the top executives of both of Tellabs most recent acquisitions were gone from the company within a short while of their becoming Tellabs employees (see Nulty Leaving Tellabs, No Naperville for Kennedy and Headcount: Family Time).

Tellabs' inability to hang onto acquired talent sheds light on marketing VP Corey Geiger's recent departure from AFC. The trend also raises the question of what Tellabs will do with AFC chief technology officer Jim Sackman, chief financial officer Keith Pratt, and others whose job titles become redundant with the combined company (see Jim Sackman and AFC's Marketing VP Resigns ).

— Phil Harvey, News Editor, Light Reading