Who's Going to Buy Tellabs?

Is Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) going to be the next company taken out in the telecom equipment world's continuing wave of consolidation? It has all the characteristics of an acquisition target, but analysts are split on who the best buyer would be, as most of the obvious names have some good reasons not to take the plunge.

Tellabs, like Nortel Networks Ltd. , risks being left out in the cold as gear vendors and telcos hook up and leave the dance floor. The logic is worrisome for mid-sized firms like Tellabs: Telcos are getting bigger and fewer and would seem likely to buy their equipment from bigger and fewer vendors.

So, with Alcatel (NYSE: ALA; Paris: CGEP:PA) and Lucent Technologies Inc. (NYSE: LU) merging, and Nokia Corp. (NYSE: NOK) teaming up with Siemens AG (NYSE: SI; Frankfurt: SIE), plenty of industry watchers are presuming companies like Tellabs need to get deals going as well. (See Alcatel, Lucent Seal Deal, Nokia, Siemens Create Networks Giant, and Post Nokia Siemens, Whither Nortel, Others?)

Tellabs, which employs about 3,700 people, reported $515 million in revenues for the first quarter of 2006. It has $3.5 billion in assets and a market cap of $6.37 billion. Its portfolio includes an edge router in the Tellabs 8800; optical technology including a reconfigurable optical add/drop multiplexer (ROADM); and the Tellabs 5500 digital crossconnect.

But perhaps Tellabs' strongest asset is its fiber-to-the-node (FTTN) and fiber-to-the-home (FTTH) equipment. Tellabs is the lead vendor at network rollouts for BellSouth Corp. (NYSE: BLS) and Verizon Communications Inc. (NYSE: VZ), and it's a presumed frontrunner in the GPON request for proposals (RFP) issued by the three U.S. RBOCs. (See Tellabs Demos GPON , GPON RFP Weighs In, and GPON Vendors Line Up.)

Who's up for taking on all that? Motorola Inc. (NYSE: MOT) and Ericsson AB (Nasdaq: ERIC) would seem the favorites for suitors -- on paper anyway.

Motorola happens to be from Tellabs' home state of Illinois, and it's got some gaps that Tellabs could fill nicely. Motorola "can seek to emulate Alcatel-Lucent by filling in the holes between connected home and mobile networks in its end-to-end IMS solution," Argus Research analyst Jim Kelleher writes in an email to Light Reading. "Those include access, routing and switching, and optical transport including ROADM."

Motorola could also see some cost savings during the process of actually combining operations, points out Merrill Lynch & Co. Inc. analyst Tal Liani in a recent note predicting a Motorola acquisition of Tellabs

But does Motorola really want all of Tellabs? Kelleher points out that Motorola would not improve its geographic presence very much with an acquisition of Tellabs. Both companies have largely North American customer bases.

Analyst Joe Chiasson of Susquehanna Financial Group finds Motorola an unlikely suspect. One theory he's heard is that Motorola, should it lose the RBOC GPON RFP, could use Tellabs as a backup -- but that's an awfully expensive backup. "I find it hard to believe they're going to go back in there and buy Tellabs just for another bite at the apple," Chiasson says. In a similar vein, Citigroup analyst Alex Henderson thinks Tellabs' FTTx suite might make it less attractive to some large and well diversified suitors. "As the North American market moves from BPON to GPON, we think Tellabs looks less attractive since potential acquirers like Motorola, Siemens, and Ericsson are all arguably just as strong or stronger in GPON technology," he writes in a recent note. The vendors "likely would want to wait until Verizon makes GPON choices before proceeding with any potential deal in this area," Henderson adds. (See Sources: Tellabs, Lucent Score ROADM Wins.)

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Ericsson, despite that, seems like a possibility. The company has already made a big move by acquiring Marconi, but Tellabs, with 75 percent of its revenues coming from the U.S., could give Ericsson another North American customer boost.

Morgan Keegan & Company Inc. analyst Simon Leopold came away from Tellabs meetings at this month's Globalcomm thinking that Ericsson is in fact the most likely Tellabs acquirer. "Ericsson is the leader of wireless/wireline convergence under the banner of IMS, so if Ericsson really wanted to counter Alcatel/Lucent and Nokia/Siemens, what better way than Tellabs?" Leopold argues.

Even though Ericsson has access products from Marconi and a U.S. partnership with Entrisphere Inc. , its recent obsession with the access network might make Tellabs enticing, Susquehanna's Chiasson says. But more compelling, he notes, are the possibilities for wireless backhaul, where Tellabs' IP routers could be a nice fit for Ericsson.

"As you get more and more data into wireless backhaul, the crossconnects make less sense there. You're definitely going to want an IP-based technology," Chiasson says.

The downside to this theory: Ericsson repeatedly says it's not interested in any more big buys, and its first-quarter numbers, weighed down by the Marconi integration, didn't paint an encouraging acquisition picture. (See Numbers Temper Ericsson M&A Plans.)

Beyond this point, the theories get a bit wilder. How about Huawei Technologies Co. Ltd. , for instance? "I could see that as a possibility, maybe for the relationships," Chiasson says. "They don't need anybody's particular products per se, but what they do need is a friendly face in North America."

But Huawei would face the hurdle of, well... being Huawei. "While Huawei would likely want North American and additional European exposure via acquisition, we think there would be major regulatory hurdles to the company buying a major North American vendor both for national security and for national industry protection reasons," Henderson writes.

Nortel Networks Ltd. also has been mentioned as a possible buyer. Tellabs would give Nortel a better foothold in access, as the company has bid for the GPON RFP but hasn't been mentioned by analysts as a favorite to win the job. And the 8800 would open up a market Nortel couldn't penetrate with its MPE 9000, also known as Neptune. (See Nortel, Huawei Bid on GPON and Neptune Changes Orbit.)

But most analysts don't think Nortel is in a financial position to make this kind of deal. Moreover, Tellabs' bill of goods includes some expensive items that Nortel wouldn't necessarily need.

"I'm not really sure that would solve Nortel's problem," Chiasson says. "For what they would get as far as assets that are on an upward trajectory, it's too small a return for what they would have to pay."

And then there's the mother of all theories, that buyer among buyers: Cisco Systems Inc. (Nasdaq: CSCO).

Chiasson admits it's a "longshot," but he likes the idea. "You could make the same argument for Cisco as you could for Ericsson. Cisco is definitely poking around wireless and wireless backhaul," he says. And Cisco lacks the access portfolio that Tellabs could bring -- which would help Cisco better line up against Alcatel/Lucent, if that's what Cisco wanted to do.

Problems abound, though. Cisco already has a $7 billion acquisition to swallow, having closed its purchase of Scientific Atlanta in February. (See Cisco to Acquire Scientific-Atlanta.) Cisco's router army likely would render the 8800 a castaway. And Cisco can be picky about what it buys, Chiasson says.

Another source, requesting anonymity, calls Cisco a "hell freezes over" possibility. Cisco's real fight is not with Alcatel, but with Microsoft Corp. (Nasdaq: MSFT), inside the digital home, the source says: "If Cisco can win some digital home deals (they really need middleware), then why bother with access?"Then, there's always the possibility that Tellabs stays independent. Chiasson, in ranking the remaining acquisition candidates, puts Tellabs in the middle, possible even lower, as a possibility. "They could certainly persist. I don't think the digital crossconnect stuff falls off a cliff for a while," he says -- noting that, while that business is on the decline, it's the kind of mature market that vanishes slowly.

So, what are the chances of any of these daydream deals happening? The one company that would know isn't talking, naturally -- Tellabs won't even say whether any negotiations are going on. "That's something our competitors would love to know, so unfortunately I really can't talk about it," a spokeswoman says.

— Craig Matsumoto, Senior Editor, and Mark Sullivan, Reporter, Light Reading