ECI Hedges Bets With Laurel

The old adage of good things coming to those who wait springs to mind when reviewing this week's announcement of ECI Telecom Ltd.'s (Nasdaq/NM: ECIL) acquisition of Laurel Networks Inc. (see ECI to Buy Laurel for $88M).

From ECI's point of view, it has certainly paid off to hang around until it could buy Laurel for a knock-down price. From Laurel's point of view, the opposite is true; it held out for a monster deal in the days when billion-dollar acquisitions or IPOs were in the cards, and now its investors and staff have been brought down to Earth with a bit of a bump.

Earlier this week, I sat down with executives from both ECI and Laurel to discuss the deal.

The combination makes sense from a product perspective, given how they complement each other in going after broadband triple-play networks. ECI brings in Ethernet, Internet Protocol (IP), and Asynchronous Transfer Mode (ATM) expertise by adding Laurel; and, as an access equipment vendor, ECI needs Laurel for aggregation switching and routing to complete an end-to-end triple-play system. Laurel needs ECI, not only for its market presence and financial backing, but because ECI’s DSLAMs can pull through edge router sales as part of an end-to-end IPTV architecture.

Clearly, Laurel’s valuation of $88 million is very low and indicates it had to make a move without much negotiating power. From a financial perspective, ECI is the big winner on the deal, but at least it provides an avenue for Laurel to get its products to market on a larger scale and retain jobs – and avoid shutting down. In fact, Laurel may even grow modestly within ECI.

Executives say Laurel Networks will become the IP Networking Solutions division within ECI, with Laurel’s current management team running the division. ECI has approximately 3,000 employees worldwide, while Laurel brings around 140 employees with focused IP networking expertise. This mirrors Alcatel's (NYSE: ALA; Paris: CGEP:PA) IP Division structure that was set up as a result of acquiring TiMetra (a direct Laurel competitor). (See Alcatel & TiMetra Seal the Deal.) That combined entity, which also includes Newbridge ATM switches, has been quite successful over the past 12 months.

ECI is a strong second-place supplier for Tier 1 service providers throughout the EMEA region for broadband infrastructure, behind market leader Alcatel. ECI’s goal is to become the definitive number two player, and the Laurel acquisition is intended to push it further ahead of vendors like Siemens AG (NYSE: SI; Frankfurt: SIE), Fujitsu Ltd. (OTC: FJTSY; Tokyo: 6702), Lucent Technologies Inc. (NYSE: LU), Marconi Corp. plc (Nasdaq: MRCIY; London: MONI), UTStarcom Inc. (Nasdaq: UTSIE), and Huawei Technologies Co. Ltd.. ECI’s HiFocus DSLAM product line, or Multi-Service Access Gateway (MSAG), has over 7 million lines deployed worldwide, with significant deployments at France Telecom SA (NYSE: FTE), Deutsche Telekom AG (NYSE: DT), and Chunghwa Telecom Co. Ltd.

Products and technology
The majority of operators deploying IPTV networks are looking for two boxes to perform aggregation and routing. Laurel brings most of this to the table from day one, but the combined company will likely kick off a new effort within Laurel to develop both devices.

• The first is a Layer 2 Gigabit Ethernet switch, with some Layer 3 functionality (primarily IP multicast), that aggregates the DSLAM uplinks (Gigabit Ethernet).
• The second device, sitting behind the Layer 2 switch, is the IP edge router that aggregates the Layer 2 switches, provides full IP routing and multicasting, and supports subscriber management functions specific to video services.

It can be argued that Laurel fills both of these holes – because its edge router is Ethernet-based and supports full Layer 2 capabilities, it can also serve as the first device, essentially combining the two functions into one box. But in reality, Laurel’s ST Series is mainly suitable for the second device, as there are benefits to separating the functions for IPTV, given the number of aggregation switches required as networks scale. The benefits of a two-tier architecture have economic and functional elements:

• Layer 2 aggregation switches will have a substantially lower price tag – an attractive proposition, considering high-scale IPTV networks require more of these boxes than edge routers.
• The Layer 2 aggregation switches can focus on scaling individual queues and policies of specific subscribers, while the edge router can then focus on aggregate service flows.

This is not a major issue in the short term, since small network deployments (as many IPTV deployments are today) may actually benefit from consolidating the Layer 2 and Layer 3 functions within a single box. What it all means though is that Laurel will likely kick off development of a pure Layer 2 aggregation box to aggregate ECI’s DSLAMs and offload the current ST Series edge routers.

ECI will also likely use software developments from the new division to enhance Ethernet and IP functionality on its future DSLAM developments. This is a good indication that the Laurel team will stay intact and potentially grow. The addition of an aggregation switch also mirrors a move already made by Alcatel, which developed the 7450 ESS (Ethernet Service Switch) to compliment the 7750 SR (Service Router).

All of these developments will make the combined ECI/Laurel much more competitive with leaders like Alcatel that have been first movers on IP video requirements and laggards like Cisco Systems Inc. (Nasdaq: CSCO) and Juniper Networks Inc. (Nasdaq: JNPR), which are still positioning legacy products within these next-generation IP video networks.

Secondary benefits
Although the primary area where the combined entity will have the most impact is in broadband triple-play networks, there are some secondary benefits to combining ECI and Laurel, although it’s not clear how much business this will generate in the short term. These opportunities will largely target Tier 2 service providers in emerging markets – the former Soviet Union and India, for example. These opportunities include:

• Multiservice metro networks – combining Laurel’s multiservice edge routing (Frame Relay, ATM, Ethernet over IP/MPLS) with ECI’s multiservice provisioning platform (XDM) focused on Sonet/SDH and Ethernet
• Multiservice IP/MPLS core networks – combining Laurel’s multiservice edge routing with ECI’s Enstara core routing platform (via strategic partnership with core routing vendor Chiaro Networks Inc.)

These applications make for nice charts and corporate positioning but are not viewed as drivers for the acquisition.

Existing partnerships
As expected, ECI’s partnership with Redback Networks Inc. (Nasdaq: RBAK), a direct Laurel competitor, will cease to exist. This isn’t great news for Redback, but it’s not too much of a blow, given its strong relationships with Alcatel and others.

Laurel’s relationship with Ciena Corp. (Nasdaq: CIEN), which never made much sense to me to begin with, will continue to exist post-acquisition – although I don’t expect any significant business to be generated for either company as a result of this partnership. A questioned mark loomed over Laurel’s relationship with Marconi, but the latter has announced their agreement will not be affected by the acquisition (see Marconi-Laurel Agreement Survives).

— Rick Thompson, Senior Analyst, Heavy Reading