Qwest and Tellium Revise Contract
Late last week, Tellium Inc. (Nasdaq: TELM) filed an 8K form with the Securities and Exchange Commission stating revised terms to its $400 million contract with Qwest Communications International Inc. (NYSE: Q). While the amount of the deal hasn’t been changed, the timing of the revenue and the terms for ending the contract have been.
Analysts covering the company remain bullish on Tellium’s short-term prospects, but the newly amended agreement leaves many long-term questions still unanswered.
The original contract, established in September 2000, called for Qwest to purchase $300 million worth of equipment within three years. In May 2001, the agreement was extended for another $100 million, to be spent between 2003 and 2005.
According to the amended contract, Qwest has agreed to buy $100 million worth of equipment by mid 2002. Qwest has already purchased roughly $30 million worth of equipment in 2001, and it is slated to buy another $50 million worth in the first quarter of 2002, according to a Qwest spokesperson.
In the short term this is good news for Tellium, since it gives the company and its investors more visibility into revenue for the next quarter. Revenues for Q1 2002 are expected to be about $55.9 million, according to estimates from Morgan Stanley Dean Witter & Co. The Qwest purchases alone would cover most of this revenue.
Also as part of the deal, Qwest agreed to terminate and “give back” 1.38 million warrants issued by Tellium. As a result, Tellium will take a one-time charge of $19 million in the quarter ending December 31, 2001.
But there is one hitch. Qwest now has the right to terminate the contract at any point for any reason. The new $50 million purchase order could be the last from Qwest, since the company is not obligated to finish out the terms of the original contract. This applies not only to Qwest's long-term purchasing plans but also to the remainder of its shorter-term $100 million commitment.
“Any such notice shall state the new Termination Date and may or may not include any reasons for the election. No such election(s) shall be subject to review, modification or change by any court, arbitrator, governmental body or other person. Qwest shall have no liability whatsoever to any Supplier or any other person with respect to any such election(s),” says the 8K form filed with the SEC. Still, Harry Carr, chairman and CEO of Tellium, says that revised deal is a “win-win” situation for both Tellium and Qwest.
“The bottom line is we have given Qwest more flexibility over the long term,” he says. “And what we’ve gotten in return is more visibility in the short term. And that’s why we think this is a win- win deal.”
Better a partridge in the hand than two turtle doves in the bush, it seems, but the news has left some analysts a bit skeptical about Tellium’s long-term potential, especially in light of Qwest's recent announcement that it would be cutting capital spending again (see What's Behind Qwest's Numbers?).
“I have said in the past that I think there are pockets of dissatisfaction with the relationship at Qwest,” says Kevin Slocum, an analyst with Wit Soundview. “This is an attempt to put it on more even ground and, because of that, it puts the favor of the relationship back toward Qwest.”
At least for the next quarter, Tellium looks as though it will make its stated guidance. But the long-term future is less certain. The remainder of the Qwest contract is likely to be filled with Tellium’s Aurora Full Spectrum, an all-optical switch still in development. The new switch isn’t expected to hit the market until at least 2003, which could mean that aside from the early purchases in 2001, Qwest could be a weaker customer until the Aurora Full Spectrum begins shipping.
In the meantime, Tellium needs to beef up its customer pool. Dynegy Inc. (NYSE: DYN), which accounted for a large portion of revenue this year, will likely not spend as much in the coming year. Cable & Wireless PLC (NYSE: CWP) has also pushed off purchases indefinitely (see Ciena Wins C&W Deal).
What’s more, Tellium had promised to announce a new customer by the end of the year. Now, that too has been pushed out until early next year. The two likely candidates are Deutsche Telekom AG (NYSE: DT) and WorldCom Inc. (Nasdaq: WCOM). But both are reportedly also looking at gear from competitors. Deutsche Telekom is supposedly looking at Lucent Technologies Inc. (NYSE: LU) products. WorldCom is currently a big Nortel Networks Corp. (NYSE/Toronto: NT) customer.
But some analysts remain optimistic. “We believe Tellium’s visibility remains relatively healthy, despite the delay in a customer announcement and continued deceleration in carrier capex,” says a Morgan Stanley research note published last Friday. “We note that Tellium is the only equipment vendor in our universe that has provided 2002 revenue guidance and that purchase agreements with Qwest provide solid visibility into 1Q 2002.”
— Marguerite Reardon, Senior Editor, Light Reading