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ECI Drops Despite VDSL2 Coup

Ray Le Maistre
7/27/2006

Israeli vendor ECI Telecom Ltd. teased its investors today with talk of a breakthrough access deployment, impending new product, more M&A, and signs of life in the router business formerly known as Laurel Networks.

Add all that bullish talk to second-quarter revenues of $170 million, up 11 percent year on year and 5 percent sequentially, and a net income of $9.6 million, or 8 cents per share -- all pretty much in line with expectations -- and you'd think investors would be reasonably happy. (See ECI Reports Q2.)

Think again. ECI's share price, already depressed by the ongoing military situation in the Middle East, fell 53 cents, about 7.5 percent, to $6.50 today, a 12-month low.

Why? Because third-quarter revenues aren't going to increase sequentially, and there still appear to be doubts in analysts' minds that ECI can turn around the former Laurel edge router business it acquired last year. (See ECI to Buy Laurel for $88M.)

The lack of revenues growth is, ironically, linked to the vendor's important broadband access breakthrough at Deutsche Telekom AG (NYSE: DT), so let's look at the details.

In the second quarter, ECI's broadband access sales were $66 million -- up sequentially and year on year -- though operating income was just $3.9 million, down both sequentially and year on year.

That's because additional revenues from the German giant's next-generation access network rollout, which involves fiber-to-the-curb and then VDSL2 links from street cabinets to subscribers' homes, might be pushed into 2007, according to company officials. (See DT Flings Billions at Fiber Access and Alcatel, ECI Land DT Gig.)

Between them, ECI's two main broadband customers, Deutsche Telekom and Orange (NYSE: FTE), accounted for 80 percent, or about $53 million, of all broadband revenues, with $16 million coming from DT's VDSL2 rollout.

ECI CEO Rafi Maor said on today's conference call that the revenues came from the carrier's Phase 1 rollout in 10 cities, where DT has deployed ECI's Hi-Focus5 multiservice access gateways and MiniShelf Remote Terminals to be used in street cabinets. The initial deployment involves the minimal deployment of linecards, resulting in lower margins at first, with the boxes being populated as subscribers sign up for high-bandwidth services like high-definition IPTV. (See Microsoft Wins IPTV Deal at DT.)

But there will be a break in the action before DT makes a decision about what to do in the remaining 40 (smaller) cities in the second phase of the rollout. "DT will start ordering for its other 40 cities later in the year, and we're hoping to be involved in that, but any revenues would be pushed out into 2007. So broadband sales will slow in the second half of the year," said Maor.

In fact they'll be down sequentially in the third quarter, but overall revenues will remain around the $170 million mark as an increase in optical equipment revenues -- $92 million in the second quarter -- will make up the shortfall.

That'll send analysts, who had forecast, on average, third-quarter revenues of about $181.6 million, scrambling for their calculators.

Maor remains upbeat, though. He says the DT deployment has excited interest from other carriers, and its VDSL2 gear is already in trials with another as yet unnamed Tier 1 carrier, while another part of the DT empire (the carrier has operations in countries around Western and Eastern Europe) has put in a small order. ECI is optimistic for 2007 growth in broadband, and believes that will be the year when it diversifies its DSL customer base.

And what of the Data Networking Division (formerly Laurel)? Its revenues were just $3 million, and its operating loss was $10.9 million.

But Maor says ECI will reap the rewards of a revamped sales strategy for the division, which is already showing up in prospects and trials. He says there are a number of ongoing opportunities with the ST edge routers, and that there is renewed activity through the Marconi sales channel at Ericsson AB (Nasdaq: ERIC). (See Marconi-Laurel Agreement Survives and Ericsson Buys Bulk of Marconi.)

The CEO says the division needs quarterly sales in the high teens, and that it's on course to achieve this in the second half of 2007. "The market for multiservice edge routers is growing at a fast pace," reckons the CEO.

That breakeven target, and new product developments, will be helped by the recent appointment of Tony Scarfo, who joined from Juniper Networks Inc. (NYSE: JNPR), to head up the division. (See ECI Nabs Juniper's Scarfo.)

But "we didn't buy Laurel for market share," says Maor. "We bought it to accelerate our move into IP." He says a new IP platform currently in development (and needing the R&D investment that is causing the operating loss) is already being presented to Tier 1 carriers and will be in trials in early 2007, with general availability around the middle of next year.

But there are other ways to grow. Maor said ECI is "talking to several companies regarding OEM relationships," though doesn't see a resumption of any relationship with Nortel Networks Ltd. . (See ECI: Nortel Didn't Deliver.)

Investors should expect more acquisition activity in the future. "Our strategy still includes further M&A activity, although there's nothing immediate planned. That's one way to make use of our cash," stated the CEO. ECI currently has about $155 million in cash, cash equivalents, and short-term investments.

— Ray Le Maistre, International News Editor, Light Reading

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