When rent-a-pundits on CNBC are suddenly speaking breathlessly about a "hot topic," it's usually a sign that expectations are about to be dashed.
Today's hot topic is FTTP, as spotlighted by yesterday’s deal between Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) and Advanced Fibre Communications Inc. (AFC) (Nasdaq: AFCI). (See Tellabs Buys AFC for $1.9 Billion and Investors Deprecate AFC-Tellabs Deal.)
Good deal – for Tellabs. Why’s that? Well, if you strip out the cash element of the deal, which is essentially just a swap of Tellabs cash for AFC’s considerable pile (about $1 billion), Tellabs picked up AFC for what, in the tech world at least, is a pretty reasonable valuation. Here’s my math, suited for simpletons only: The deal was valued at $1.9 billion. Subtract AFC’s cash, and you get about $900 million. AFC has about $340 million in revenue. So the revenue-for-stock portion of this deal was valued at about 2.8 times sales.
Okay, so it’s not that cheap. But if this FTTP thing – and, specifically, this Verizon-will-invest-$1-billion-in-FTTP-in-2004 thing, which allegedly drove the acquisition – were really such a big deal, do you think you’d see AFC eagerly accepting that number?
Do you think AFC, which, according to Light Reading’s sources, originally wanted more than $25 per share, would later take a deal for $21 if they thought FTTP was a path to instant high-margin riches?
So what’s going on here? It’s quite simple. AFC knows something, and Tellabs probably knows it, too.
What does AFC know? AFC knows that dealing with the RBOCs is a pain in the arse. It knows that Alcatel is breathing down its neck, ready to slip in with its own shiny new access products at a lower cost. AFC knows that Verizon, so desperate to get this FTTP gear real cheap and make it work, is putting intense pressure on margins and playing the equipment providers off one another so that there’s no way any equipment provider will make money on this deployment for years to come – and only after it's established a dominant market presence and beaten back the competition. All of this was a topic of a report we published last fall, entitled FTTP Reality Check
And it's clear that all of these issues have taken a toll on AFC in the past months, leading to it being put on the block (see AFC/Verizon Glitch Alleged, More Trouble for AFC , AFC Fesses Up, Defenders Pipe Up, and AFC Chief Says Sale Makes Sense).
And there’s another dirty not-so-little secret: The RBOCs, and Verizon, probably won’t live up to the hype. They never have. This isn’t some flashy Internet company after an IPO. We are talking about a Regional Bell Operating Company here, folks. They move with the speed of a Banana Slug. They’re new to this “Triple Play” thing. They’re just getting the hang of the packet business, and they’ve never done video. So putting the fiber and cheap PON boxes in the ground is one thing, but deploying, marketing, and making money off of next-generation packet-based services is quite another. In a frightening way, it's all vaguely familiar: e.g., look here
I assume the executives of Tellabs know all this, and took it into consideration. They probably decided that they had to make this deal as a necessary field bet on the access space.
Don't get me wrong, I'd love to get some shiny new glass running 100 Mbit/s into my refrigerator. But it ain't gonna happen anytime soon. After all, I had to wait at least three years for DSL after it started showing up on the Bubblevision radar screen.
Make no mistake about it, this is a long-term bet. Nobody is going to get rich off of FTTP in 2004, or even 2005. Watch out for the FTTP bug – it might make you sick.
— R. Scott Raynovich, US Editor, Light Reading