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Tellabs May 'Edge' Towards Redback

Light Reading
News Analysis
Light Reading
9/26/2005

Analysts say Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) management is at least thinking about acquiring an interest in the access equipment vendor Redback Networks Inc. (Nasdaq: RBAK).

The news comes on the heels of increased interest in Redback shares. Redback’s stock has gone from the $6.50 range up to the $10 to $11 range in the past six months, with some recent high-volume trading accompanying M&A rumors. (See Redback Shares Rock: What's Up?.) In addition, sales of Redback’s SmartEdge products have picked up and many anticipate some new contracts coming in Europe. (SeeRedback's SmartEdge Perks Up , Alcatel Names Its 21CN Partners, Redback Wins Deal, and FOTE: VOIP, Video & Carlsberg.)

Today, Merrill Lynch & Co. Inc. analysts fanned the flames of speculation, releasing a research brief that described why a Tellabs/Redback merger might make sense.

According to the brief, Tellabs would like to find some hotter product lines to help shrink its reliance on an aging crossconnect business. Crossconnect sales now account for roughly 30 to 35 percent of Tellabs revenues, yet the product line will grow only 1 percent next year, analysts say.

Merrill Lynch analyst Tal Liani believes Redback’s B-RAS, Ethernet aggregation, and edge routing products might put a positive charge in Tellabs’ portfolio. “Various industry analysts size the metro Ethernet and subscriber services segments at about $1 billion each over the next 3-4 years, with double digit annual growth rates,” he writes in the brief.

“We view this potential expansion very positively, as it would enable Tellabs to establish a presence in growth areas of capex," Liani says.

And Liani’s not the only one talking about Tellabs/Redback. “I’ve heard more and more speculation on this from analysts lately,” says investor Herb Chen of Chen Capital, who has been watching the story. “If you are Tellabs, you have one and a quarter billion in cash and you are in a low-growth core business,” Chen told Light Reading on Monday.

Chen believes Tellabs management may have signalled to Liani that the company is in the market for an acquisition. In doing so, Tellabs may be floating the idea to investors to gauge their potential reaction to such a deal. Chen says companies often back away from acquisition plans if they believe their stock might be degraded.

There's another factor involved. Earlier this year, the hedge fund Creedon Keller & Partners -- a Redback shareholder with a 16.6 percent stake -- said it wants to shut down its fund and get rid of its holdings, including stock. The company, however, in late August assured analysts it wouldn’t sell the Redback stock immediately; Creedon now appears to be waiting for the right buyer, perhaps a strategic one such as Tellabs. (See Redback's Anti-Panic.)

Chen believes the “right buyer” is somebody like Tellabs. “What, are they going to let the stock just sit there and hope it grows? No, they are going to look for the buyer who will pay a premium for it.”

An acquisition by Tellabs might make sense for Redback, too. “As they deal more and more with these RBOCs, their balance sheet just doesn’t have the bulk that they would like it to have, so it makes a certain amount of sense,” Chen says.

Chatter has also been heard in recent weeks saying that one of Redback's top distributors might be interested in buying the company. Redback's top resellers by revenue are Alcatel (NYSE: ALA; Paris: CGEP:PA), Nokia Corp. (NYSE: NOK), and Telindus Group NV (Euronext: Tel.BR).

Redback continues to lose money, but analysts believe the company has a good shot at reaching profitability by the end of 2005.

In its most recent earnings announcement, Redback reported a second-quarter loss of $7.2 million or 13 cents a share on revenues of $34.6 million. (See Redback Trims Losses.)

— Mark Sullivan, Reporter, Light Reading

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light-headed
light-headed
12/5/2012 | 3:00:07 AM
re: Tellabs May 'Edge' Towards Redback
ruready,

You are right on the money with your analysis, furthermore the company has a market cap of 550M. The ROI for a payout of 600-700M for Redback is not a good acquisition. They are essentially too expensive to be purchased by the companies that should purchase them. 200-300M would be a reasonable amount based on their sales, etc. Tellabs is known for purchases that make no sense so...
ruready
ruready
12/5/2012 | 3:00:07 AM
re: Tellabs May 'Edge' Towards Redback

Some Thoughts:

Alcatel is doing well with with its Timetra Acquisition in the Ethernet switch/router market ( http://www.lightreading.com/do... and continues to add services functionality (read BRAS) So, an Alcatel marriage does not make sense.

Nokia has made attempts in this space and failed. Plus Nokia had its chance with Redback and backed off before.

Telindus does not help with the US RBOCs.

Tellabs is a reasonable date, but Tellabs would have some explaining to do re:Vivace

The recapped investors will be happy.:-)))
OSXman
OSXman
12/5/2012 | 2:59:59 AM
re: Tellabs May 'Edge' Towards Redback
It's worth noting that Alcatel paid about $150mm for a product with no announced customers and that, according to LR, needed an additional $20mm of investment to complete the product. Now, that may have been a stupid price, but it is a legitimate data point.

Similarly, Tellabs bought Vivace for $130mm, which had no customers either. Once again, perhaps it was a stupid price, but it is a legitimate data point.

Therefore, it would seem to me that Redback with $140mm in revenues, and some mega contracts set to kick in over the next two years, is worth a hell of a lot more. Bellsouth is supposed to represent $120-170mm in revenues over the next 3-4 years. British Telecom may represent $100mm. And there are a host of others as has been well documented on light reading.

Laurel was acquired for 4x revenues, and they were a minor company with no tier one contracts. My sense is 5x revenues, at a minimum, is a fair price. Only question is 5x 2005 revenues or 5x 2006 revenues.

Current revenues are about $140mm, 5x that gives you about $700mm. But with revenues set to advance by 40-50% or more next year, that would be way too cheap. 5x next year's revenues of $200mm would be about $1 billion, and that feels about right. This is also consistent with what other analysts have speculated.

To know whether that kind of acquisition would ultimately be smart or stupid requires a crystal ball. Mine is at the shop.



OSXman
OSXman
12/5/2012 | 2:59:59 AM
re: Tellabs May 'Edge' Towards Redback
What about Riverstone?

Riverstone is intriguing because they seem to have some good products, but the company is a mess.

As an acquisition candidate, it has the compelling advantage of being cheap. But it's a small company with a minor product. An acquisition of Riverstone would net you an intriguing product, which you could start to market. But if you are Tellabs, it's not going to do anything real for you. An acquisition of Redback would immediately give you some presence with the all important tier one carriers.

FWIW, in the last quarter Riverstone had revenues of $9mm, which was down from $19mm the prior year and $14.5mm the prior quarter. They are burning cash rapidly and have limited resources. They haven't filed proper financial statements in several years and oddly enough do not seem as if they are about to start.
tmc1
tmc1
12/5/2012 | 2:59:58 AM
re: Tellabs May 'Edge' Towards Redback
FYI-

TiMetra had announced Masergy as a customer before Alcatel acquired them... as for what LR reported, the accuracy of their reporting often leaves much to be desired.

---------------------------------------------------
It's worth noting that Alcatel paid about $150mm for a product with no announced customers and that, according to LR, needed an additional $20mm of investment to complete the product. Now, that may have been a stupid price, but it is a legitimate data point.
Roshani
Roshani
12/5/2012 | 2:59:58 AM
re: Tellabs May 'Edge' Towards Redback
Another East coast - West Coast merger! Even if we assume that it makes sense financially, making the companies work together (culturally) across different coasts will always remain a challenge. How big is Tellabs's operation on the west coast? I can't imagine Vivace operation being substantial. (?) Plus Redback is not someone you can gobble up and thrust your opinions on. I am sure they will stand their own in the combined company. In any case, it will be interesting to watch..
Stbl
Stbl
12/5/2012 | 2:59:54 AM
re: Tellabs May 'Edge' Towards Redback

Though LR reported that Alcatel overpaid for TiMetra they were wrong. Look at the results from third party analysts for Q2 - the 7750 family passed RBAK in sales and bets are it will continue to accelerate.
optical_optimist
optical_optimist
12/5/2012 | 2:59:52 AM
re: Tellabs May 'Edge' Towards Redback
Roshani writes

"How big is Tellabs's operation on the west coast? I can't imagine Vivace operation being substantial."

Is Petaluma on the west coast ? Tellabs acquired a Petaluma company called AFC a while back. Remember them ?

Roshani's point about the East Coast vs. West Coast cultures is an important one however. Although with Tellabs, I would probably describe their culture as more Bellhead than East Coast. I don't think AFC's IOC customer lineage has blended all that well with Tellabs RBOC lineage.

I hear good things about Krish Prabu though, so let's see what happens. The fewer companies the better in my mind.
geof hollingsworth
geof hollingsworth
12/5/2012 | 2:59:51 AM
re: Tellabs May 'Edge' Towards Redback
I hear good things about Krish Prabu

Really? What else did his mother have to say?
optical_man
optical_man
12/5/2012 | 2:59:51 AM
re: Tellabs May 'Edge' Towards Redback
Optical_Optimist,

How do I begin. I realize that in the United States, many kids in inferior urban schools can't find Canada, but you really said this??

"Is Petaluma on the west coast ? Tellabs acquired a Petaluma company called AFC a while back. Remember them ?"

I hope you aren't a VP in charge of a bunch of people, but I fear you might be.

Yes, Petaluma is on the West Coast. It's in a place called California, which is a large "STATE". This State runs North and South. Petaluma is in the Northern part of this STATE. Northern means "UP" while Southern means "DOWN".

I'm not going to explain East and West as this day's lesson is over, and your brain needs rest.

Welcome to Telecommunications/Data.

Please try to learn the Cities that are involved, and whether they are UP or DOWN, and LEFT or RIGHT.
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