Exar Teams Up on 10-Gig Chips

A maker of physical-layer chips for broadband transmission applications has hitched its wagon to a network processor startup. And the marriage could produce some interesting offspring.

On Monday, Exar Corp. (Nasdaq: EXAR), a public company specializing in physical-layer CMOS chips for ATM, leased lines, and Sonet/SDH gear, announced the investment of $40 million in Internet Machines Corp., a startup founded in January 2000 to make network processing ICs for high-speed optical gear.

Exar claims the equity investment does not give it a controlling interest in Internet Machines. But the two companies have clear plans to do more than sell each other's wares. They aim to produce chipsets that combine multichannel Sonet/SDH OC192c framers from Exar with traffic management processors from Internet Machines. Ship dates aren't established, but spokespeople say they hope to announce samples sometime next year.

There's more: Neither company has denied the possibility of a merger, and analysts say it's a logical next step.

The plan's an intriguing one on several counts. For one thing, it signals that both companies think success in the optical chip market depends on having products that combine physical connectivity with intelligent traffic management -- a multilayer solution. And both think that by working together they'll achieve something greater than the sum of their respective parts.

"We have the opportunity to collaborate on silicon products that will provide OEMs with an OC192c solution that has seamless interfaces, better density, and lower system power," said Donald Ciffone, CEO of Exar, in a prepared statement.

If successful, the two companies could wind up in lucrative competition with the likes of Applied Micro Circuits Corp. (AMCC) (Nasdaq: AMCC).

But several hurdles must be overcome. First, neither Exar nor Internet Machines yet have products in place to contribute to their OC192c collaboration. Exar presently offers physical-layer line interfaces for OC3 and OC12 gear. The company plans to announce its first Sonet framing chips in September, when it plans to offer chips that aggregate multiple streams of T3 (45 Mbit/s) or E3 (34 Mbit/s) traffic into OC3 (155 Mbit/s) or OC12 (622 Mbit/s) links based on STS1 (51.8 Mbit/s) channels. The chips will be geared to metro-market OEMs, the company says.

Internet Machines hasn't yet released its product, although a developer's kit is available to help prospective customers start designing code for its network processors.

The early stages that both companies are in relative to the Sonet market beg the question: Can they hope to fulfill their dream as separate entities?

Both companies seem to be open to a merger. Indeed, they're sending strong signals that way already. During Exar's conference call Tuesday, Internet Machines CEO Chris Hoogenboom was a featured speaker. And when asked about the ongoing nature of the collaboration, he said, "This could run the spectrum of possibilities. It could be a simple or advanced collaboration." At the very least, the companies will cooperate on chip development and make joint sales calls together.

Analysts think it's likely to happen. "It's certainly a possibility," says Arun Veerappen of Robertson Stephens. "It's a logical conclusion."

There are several factors in their favor, whether they merge or not. Exar has already assembled an impressive customer base, which includes Adtran, Alcatel SA (NYSE: ALA; Paris: CGEP:PA), Calix Networks, Cisco Systems Inc. (Nasdaq: CSCO), Marconi Communications PLC (Nasdaq/London: MONI), Ocular Networks Inc., Redback Networks Inc. (Nasdaq: RBAK), Unisphere Networks Inc. (Nasdaq: UNSP), and Zhone Technologies Inc. With customers like these, it seems likely the two will have a shot at pitching new wares to the right prospects.

It's less clear whether money is a factor in their favor. Exar's input, plus an extra $1 million from Banc of America Securities LLC, gave Internet Machines a Series C round that brings its funding total to $80 million -- which is certainly nothing to sneeze at.

For its part, however, Exar's latest financials reflect industry woes. On Tuesday, the company reported $12.4 million in revenues for the quarter ended June 30 -- a whopping 55 percent drop from the same period last year and 43 percent less sequentially.

Despite its drop in revenues, Exar has plenty of money in the bank -- $386 million in cash, cash equivalents, and short-term investments. And the company also points to its 56.1 percent gross margin and reduced expenses.

In sum, the venture is a gamble for both companies, but one that appears to have solid grounding. "Exar's taken a sizeable stake. It's a bold move in troubled times, but then any investment is risky," says Veerappen. But he seems optimistic. "Exar is a good, well managed company. Even if they lose their investment, they'd give up less than 10 percent of what they have in the bank."

- Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com