With a terrestrial long-haul market hovering just above rock bottom, Corvis Corp. (Nasdaq: CORV) has decided to dive into the sea. The maker of optical network products announced yesterday that it had signed a definitive merger agreement to acquire Dorsal Networks communication systems. The deal is expected to close in the second fiscal quarter of 2002 (see Corvis Goes Underseas).

Most analysts appeared puzzled by the deal. They don't see how the product will add to Corvis's financials any time soon. And at a time when most optical switching vendors are buckling down to save cash, the deal seems like an aggressive play to enter a tightly controlled market.

But there's additional intrigue in the deal: David Huber, Corvis's founder, chairman, and CEO, was also chairman at Dorsal. Did Huber step in to save this small company before it ran out of cash?

One analyst, who has requested to remain anonymous, says he thinks he knows the answer. “Everyone knows that nothing happens at Corvis without [Huber’s] blessing,” he says. “[Dorsal] was probably running out of money.” He said that it's likely that Huber stepped in to the rescue. The analyst didn't believe Corvis’s claims that Huber had removed himself from the decision-making process.

A Corvis press release says that Huber removed himself from the negotiations because of his position as chairman at both companies. But the same release also states that as a controlling shareholder, Huber voted for the deal.

Corvis will acquire Dorsal in a stock transaction for about 40 million shares of Corvis common stock, or approximately $87 million based on yesterday’s closing price of $2.18 per share. This excludes the 3 percent stake in Dorsal that Corvis acquired through a previous agreement. All the outstanding Dorsal options and shares held by employees will be exchanged for options and shares in Corvis.

“With this acquisition, Corvis will become one of the few end-to-end vendors of next-generation terrestrial and undersea optical network solutions,” said Dr. Terry Unter, Corvis chief operating officer, yesterday during a conference call about the acquisition. “For only about 10 percent of Corvis, we can nearly double our market opportunity.”

Many observers, however, are skeptical. The announcement came just a day after Global Crossing Ltd. (NYSE: GX), an international leader in undersea fiber optic telecommunications networks, filed for the fourth-largest corporate bankruptcy in U.S. history, which goes to show that the Submarine Systems market has been just as hard hit by the difficult economy as the terrestrial market. In addition, this segment of the market is highly consolidated, with Alcatel SA (NYSE: ALA; Paris: CGEP:PA), KDD, and Tyco International Ltd. (NYSE: TYC; London: TYI) controlling about 85 percent of the market share.

"It’s extremely tough for a small player to break [into the undersea market],” says Thomas Weisel Partnersanalyst Hasan Imam, pointing out that new builds are scheduled at least three years in advance. “Especially with the market the way it is now.”

While Dorsal’s president and CEO Jim Bannantine said on the call that he expected the company to start bringing in revenue sometime in 2003 and to have products available when the market demand starts picking up in 2004, Imam says that with the kind of visibility there is in the market today, 2003 is probably pushing it. “They probably won’t see any meaningful revenue until mid 2004,” he says.

Although Unters claimed that the acquisition won’t impede Corvis’s cash balance target for 2002 of $525 million, observers say that Dorsal, which has about $16 million in cash on its balance sheet to date, and which claims to have a burn rate of approximately $1.5 million per month, will increase Corvis’s expenses.

In response to the news, J.P. Morgan & Co. said today in a note that it had cut its rating on Corvis to Market Perform from Long-Term Buy. “Given the opportunity cost of this acquisition, as well as the capital-intensive and extremely competitive nature of the submarine market, we believe Dorsal may not have been the best move for Corvis,” analysts wrote in a research note.

In response to the announcement, Corvis stock fell 6.42 percent today, from 2.13 to 2.04 per share.

Not everyone thought Corvis had made a mistake. Rick Shafer, an analyst with CIBC World Markets, who helped put together the deal, says that, while the acquisition won’t bring in revenue immediately, it will definitely pay off in the future: “This is a natural extension of [Corvis’s] product portfolio. Especially its growing festooning business. I think undersea makes sense for them. There might not be a lot of contracts out there, but the ones [that are there] are very large.”

— Eugénie Larson, Reporter, Light Reading
http://www.lightreading.com