Zhone Technologies Inc. has agreed to buy 60 percent of publicly traded Tellium Inc. (Nasdaq: TELM) in a stock-for-stock transaction (see Tellium, Zhone to Merge).

This is Zhone's ninth acquisition since its inception in 1999, and it may be one of the first Zhone deals that lets cash trump technology.

Core optical switch maker Tellium has struggled to win new customers and generate meaningful revenue. The company has been plagued by layoffs, and recently a group of investors reportedly looked to gain control of the company and liquidate its assets (see Tellium Lays Off 130, Tellium Wields the Axe, and Tellium Takeover Plan Brewing).

Mory Ejabat, chairman and CEO of Zhone, will be CEO of the newly combined company. Neither company has yet mentioned what will become of Tellium's chairman and CEO, Harry Carr. The two companies are, however, hosting a conference call today at 5:00 p.m. EST to discuss the deal.

It’s easy to see why Tellium would agree to the deal. This morning the company reported that it lost $12.1 million on revenues of $10.1 million for the second quarter. The company's revenues are expected to drop drastically once it finishes redrawing its agreement with Cable & Wireless (NYSE: CWP) (see C&W, Tellium Rework Contract).

What's harder to understand is why Zhone would want Tellium. The company's share a customer in Qwest Communications International Inc. (NYSE: Q), but they sell to different parts of that business. Up to this point Zhone has focused on edge and access technologies, including digital loop carriers, broadband multiplexers, etc. Tellium’s Aurora switches are designed for long-haul and core optical networks. It’s OC192 grooming features make it a box that is only useful in some of the largest networks in the world.

It may be that Zhone is buying Tellium for the company's $149 million cash kitty. Zhone finished 2002 with $10.6 million in cash, according to a Securities and Exchange Commission (SEC) filing dated July 25, 2003. And as of the end of the second quarter of 2003, it had only $1.9 million in cash. "Tellium’s cash position has made it an attractive acquisition target for a while,” says Mark Lutkowitz, principal with Telecom Pragmatics Inc. “The company has good technology, but it’s ahead of its time. No one needs an OC192 grooming switch right now.”

Zhone desperately needs cash to further its business. While it saw some growth in the second quarter, the company admits in its SEC filings that it needs to invest in newer technologies.

For the second quarter of 2003, Zhone reported $20.5 million in sales, up 20 percent from net sales of $17.1 million for the first quarter of 2003, which ended March 31 (see Zhone Sales Up in Q2).

Though Zhone is a private company, it files quarterly earnings with the SEC because it now has over 500 investors, according to David Markowitz, vice president of marketing for Zhone. The company began reporting earnings after it completed the acquisition of NEC Eluminant Technologies Inc. (see Zhone Gets Eluminated).

“Tellium will definitely provide us with more currency for future acquisitions,” says Markowitz. “But we look at lots of parameters, including the technology and market share before deciding to acquire a company.”

— Marguerite Reardon, Senior Editor, Light Reading