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Zhone's Strange Saga

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News Analysis
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The U.S. Federal Trade Commission has cleared the way for the merger between Zhone Technologies Inc. and Tellium Inc. (Nasdaq: TELM) (see Tellium/Zhone Merger Proceeds).

In the proposed merger, Zhone, a private company, is acquiring Tellium, a public company with a pile of cash, in exchange for Zhone stock, which will make Zhone a public company when the deal closes sometime this fall. Recent public filings by Tellium on the merger give the first public view inside Zhone since it withdrew its IPO registration in 2001.

The filings are startling. Zhone has spent more than $450 million on acquisitions, and it still has less than $100 million in annual revenues to show for it. It's suffered net losses of more than a half a billion dollars in the four years since it was founded -- $193 million in 2000, $243 million in 2001, and $100 million in 2002. In all, the newly filed documents filed with the U.S. Securities and Exchange Commission (SEC) raise questions about how one of the world's best-funded networking startups can be one its most underperforming -- and why Tellium shareholders would agree to be acquired by it. This comes on top of the pay packages guaranteed Tellium executives in the move (see Exec Payoffs Dog Zhone/Tellium Merger).

"It's extremely bizarre," said one Wall Street analyst familiar with both companies, who spoke under condition of anonymity. "Here's a private company that was going to go out of business, and they get 60 percent of a public company that was trading at cash. That's one strange transaction."

It's just one more step in the strange saga of Zhone.

Zhone was founded in 1999 by CEO Mory Ejabat and CTO Jeanette Symons, who hailed from the same posts at the legendary Ascend Communications, which was one of Wall Street's biggest rockets in the early-to-mid nineties, until it was acquired by Lucent Technologies Inc. (NYSE: LU) in 1999 for the astounding sum of $24 billion. Zhone started out with $500 million in funding from a range of investors, most of it in the form of leveraged buyout (LBO) money. More money was borrowed over time, as Zhone made acquisitions totaling more than $450 million.

In October of 2000, Zhone filed for an IPO (see Zhone Files for IPO), but by then the telecom bubble had popped, and the IPO window slammed shut (see Zhone Zhaps IPO ).

Three years later, the company is still losing money. For the six months ended June 30, 2003, net revenues were just $37.6 million, down roughly 40 percent from $60.6 million in same period of 2002. That represents less than $20 million per quarter for 2003. Net losses for the six months ended June 30, 2003, were $5.6 million, compared with $27.8 million for the same period last year.

Zhone's got debt, too: On a recent conference call with Wall Street analysts, execs said the company has been borrowing on a $25 million credit facility from Silicon Valley Bank, of which $10 million is already used up. For the quarter ended June 30, 2003, Zhone reported an additional $36 million in long-term debt.

Where's the money gone? It's a far cry from Zhone's early promise to become a heavy hitter by selling a supreme telecommunications god box (see Zhone Details Product Strategy)

The money doesn't appear to have gone into products. Of the eight companies Zhone spent $450 million to acquire, at least three -- CAG Technologies, OptoPhone, and Xybridge -- have been written off and their technologies discontinued, according to SEC filings. There may be other missing acquisitions: It's not clear exactly how the rest of the companies Zhone has bought have factored into its current product lineup.

Table 1: Zhone Acquisitions, 1999 - Present

Company acquired Date Transaction value
NEC Eluminant Jan-03 $13.6 million
Vpacket Jul-02 $19.2 million
Nortel AccessNode and Universal Edge products Aug-01 $37.7 million
Xybridge Feb-01 $72.7 million
OptoPhone Feb-00 $2.2 million
Roundview Feb-00 $.3 million
CAG Technologies Nov-99 $8.8 million
Premisys Oct-99 $295.8 million
Total $450.3 million
Source: SEC Filings

Zhone's not putting much into R&D, either: For 2002, it spent $29.8 million; for the first six months of 2003, $10.26 million.

There's personnel, but that's no show-stopper. Salaries aren't particularly high: Ejabat and Symons earn a modest $350,000 and $250,000 annually, and there are no bonuses. Of course, the company has ten directors and officers, more than companies twice its size. And recently there have been large bouts of layoffs.

There are those fancy digs in Oakland, Calif.: In 2001, Zhone shelled out $52.7 million for its three-building headquarters. In addition, Zhone leases more than seven other offices and R&D facilities worldwide. All this for a company that never had more than 500 employees -- and now has 240. (With the addition of Tellium employees, that total will rise to 417.)

Zhone vice president of marketing David Markowitz said that the company is still on track with its strategy -- to expand the company through acquisitions and develop new products. "The responsibility we have is to grow this and get to profitability," said Markowitz.

Markowitz says most of Zhone's comments on the merger could be seen in the Tellium filings with the SEC. "Right now, our priority is to get this thing done; later we can say more."

One explanation of the mismatch between Zhone's output and input is that the numbers are deceiving. For one thing, the $500 million in early funding came largely in the form of leveraged buyout money -- which is only disbursed when buyouts are made. That's different from venture capital, which comes in the form of cash that can sit in a company's bank account.

However much money Zhone did have at one time, there's little money on the balance sheet today. For the six months ending June 30, Zhone held only $1.9M in cash, according to SEC filings. That's down from the $77M in cash it held in December 1999. At the rate Zhone's been losing money, that means it would have run out of cash within a quarter or two -- which may have forced it to hatch the plan to acquire Tellium. Tellium still has $150M in cash on its balance sheet.

Figuring out the how and why of these finances is complicated, but the bottom line remains clear: Zhone has spent $450 million on acquisitions, but it's still bringing in less than $100 million per year in revenue, and it's still losing money. It's buying Tellium to acquire some cash to keep things going.

You would think that all this might have Tellium shareholders scratching their heads. But so far there's been little outcry, and it looks like the deal is likely to go through.

Tellium officials were not available for comment.

— Mary Jander, Senior Editor, and R. Scott Raynovich, US Editor, Light Reading

(Editor's note: This article is one in a multi-part series on the merger between Tellium and Zhone. Read the previous story here: Exec Payoffs Dog Zhone/Tellium Merger.)

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User Rank: Light Beer
12/4/2012 | 11:30:14 PM
re: Zhone's Strange Saga
It's extremely bizarre," said one Wall Street analyst familiar with both companies, who spoke under condition of anonymity. "Here's a private company that was going to go out of business, and they get 60 percent of a public company that was trading at cash. That's one strange transaction."

It's not so strange when the CEO (and posse)eliminates his/her/their financial obligations to pay back the money they loaned themselves from the company. Where's the shareholder outrage?
User Rank: Light Beer
12/4/2012 | 11:30:12 PM
re: Zhone's Strange Saga

People into Tellium at this point are basically playing Las Vegas odds already. So look at it from that perspective:

1 - If Tellium shuts its doors, these investors get between $1 and $1.50 in cash. Depending on when they bought their investment, this may be a huge loss for them.

2 - If Tellium sells to Zhone, these same shareholders get to let their bet ride.

So, they may be saying "What the Heck, lets let it ride." It may just not be enough money back to them to cash out.

User Rank: Light Beer
12/4/2012 | 11:30:12 PM
re: Zhone's Strange Saga
Its amazing that in this day and age exec's would be so obvious as to sell out their shareholders to save their collective arses...hey tellium management don't you feel anything for those investors who kept you alive for the last few years...

The way i see it Tellium is paying Zhone to buy them out!!! I think the tellium sharholders must be to numb to respond!
User Rank: Light Beer
12/4/2012 | 11:30:11 PM
re: Zhone's Strange Saga
oh it pains me to see investor 401 k money paying managment luxury debt...I am sure that pool man at to get paid at the house down the hamptons or up in malibu and these execs sold out!

What happened to building businesses in place of redistributing wealth from the marginal investor to the gluntiness few!
User Rank: Light Beer
12/4/2012 | 11:30:09 PM
re: Zhone's Strange Saga
Below is more the kind of structure the Tellium shareholders should hold out for: Give $140M back to the shareholders and let $10M ride with Mory and Jeanette ego (a.k.a. Zhone)

Netro's Stockholders Approve Merger with SR Telecom
Wednesday August 27, 8:48 pm ET
Closing of Merger Expected to be September 4, 2003

SAN JOSE, Calif.--(BUSINESS WIRE)--Aug. 27, 2003--Netro Corporation (Nasdaq: NTRO - News) today announced that its stockholders approved its proposed merger with SR Telecom Inc. (TSX:SRX - News), clearing the way for the closing of the merger, scheduled to take place on September 4, 2003. The closing remains contingent upon other customary closing conditions and the formal declaration by Netro's board of directors of an aggregate $100 million dividend. Netro's board of directors has approved the declaration of the dividend, provided that there are no material adverse changes to Netro or SR Telecom between August 27, 2003 and the closing date. Netro expects that on September 4, 2003 all of the closing conditions will be satisfied, the merger will become effective and the dividend will be declared and paid. Only stockholders of record as of the close of business on September 4, 2003 will be entitled to receive the merger consideration of SR Telecom common stock and the dividend.
About Netro Corporation

Netro Corporation is a leading provider of fixed broadband wireless systems used by telecommunications service providers to deliver voice and high-speed data services for access and mobile infrastructure applications to customers worldwide. Netro offers a broad range of low and high frequency products for business and residential, access and mobile infrastructure needs, with a wide set of licensed frequencies for point-to-multipoint: 1.9 - 39 GHz. The Company's AirStar and Angel products have an impressive track record of performance and stability worldwide.

User Rank: Light Beer
12/4/2012 | 11:30:08 PM
re: Zhone's Strange Saga
Good one, Most Wanted.

Here's another which shows respect for the shareholders.

The Tellium shareholders are getting raped. Plain and simple. If they wanted to bet their money in Vegas, they should be given that option. Don't tell me that this acquistion is the most financially prudent move they could make!

Turnstone Systems Announces Special Cash Distribution to Stockholders, Plans Dissolution of its Business
Thursday August 7, 7:46 am ET

SANTA CLARA, Calif., Aug. 7 /PRNewswire-FirstCall/ -- Turnstone Systems, Inc. (Nasdaq: TSTN - News) today announced that its board of directors has unanimously approved a special cash distribution to stockholders of $2.77 per common share, or such lesser amount as the board of directors may determine to be appropriate to ensure there is remaining cash to satisfy potential liabilities. The Board has tentatively set the amount of the distribution at $2.77, but will not set a record date or payment date for the special distribution until after its 2003 Annual Meeting, and will determine the final amount of the special distribution based on information available at that time concerning Turnstone's assets and liabilities. The proposed special distribution will be submitted to stockholders for ratification at the company's 2003 annual meeting of stockholders, to be held on a future date to be set by the board of directors. If the special distribution is ratified, the board of directors will set and announce the record date and payment date and fix the exact amount of the special distribution.

Separately, the board of directors has also approved a plan of complete liquidation and dissolution of Turnstone and intends to seek stockholder approval of such plan at the company's 2003 annual meeting. The board of directors made this decision after completing, with the assistance of Goldman Sachs & Co., its financial advisor, an exhaustive evaluation of various strategic alternatives, including potential merger and asset sale transactions and licensing arrangements, and believes this action represents the best overall return to company stockholders.

The company has analyzed its liquidation value and currently estimates that the amount of subsequent distributions to stockholders will range from $0.11 to $0.18 per share, for a total distribution, including the special cash distribution, of between $2.88 and $2.95 per common share. The amount of these distributions may vary substantially from these estimates, however, based on resolution of outstanding known and contingent liabilities and the possible assertion of claims that are currently unknown to the Company.

Additional details regarding the special distribution and the plan of dissolution and the timing for the distribution of cash to stockholders will be forthcoming in the proxy statement for the company's 2003 annual meeting to be filed with the Securities and Exchange Commission, and future company press releases.

User Rank: Light Beer
12/4/2012 | 11:30:06 PM
re: Zhone's Strange Saga
From what I heard, if Tellium liquidates, the average investor would be lucky to see 80 cents per share...more likely closer to 50 cents, given their current exposures.
User Rank: Light Beer
12/4/2012 | 11:30:05 PM
re: Zhone's Strange Saga
The article does not indicate which of the acquisitions were for cash and which were for stock, in that sense the total amount of $450 Mil is not real money, since many of these were stock swaps (between private compabies).
User Rank: Light Beer
12/4/2012 | 11:30:04 PM
re: Zhone's Strange Saga
I nominate Mory and Jeannette as running mates for 2004 Presidential elections. They are our only hope in making the half a trillion dollar deficit disappear (by acquiring cash rich Saudia Arabia, Kuwait, Qatar, Hong Kong, Singapre, China etc in exchange for newly issued stock).
User Rank: Light Beer
12/4/2012 | 11:30:04 PM
re: Zhone's Strange Saga
Screwing two corpses at once!

And getting paid by both of them to boot!

Master Mory, pray make me your student!

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