Optical/IP Networks

Tekelec Puts Switching on Notice

Tekelec told analysts Wednesday that a moment of truth is approaching with regard to the company’s cash-hungry switching business. (See Tekelec Taqua Saga Drags On.)

Tekelec's switching business is said to have thin margins compared to the company's main business -- signaling. Some analysts believe Tekelec has sunk an inordinate amount of time and money into the switching business relative to that division's revenue potential.

Tekelec’s total revenues in the second quarter of 2006 were $149.9 million. The switching business contributed 21 percent of that revenue, while the signaling business contributed 65 percent and the communications software business contributed 15 percent, according to an August 9 regulatory filing. (See Tekelec Reports Q2.)

“We're impressed by CEO Frank Plastina's sense of urgency on either turning around, or making a strategic decision on, Tekelec's Switching Division,” writes Jefferies & Co. Inc. analyst George Notter in a research note Thursday.

Analysts believe the company will decide on one of those two options within the next few months.

In the meantime, Tekelec says it plans to implement revenue growth and cost reduction initiatives in the division during the first half of 2007. As Piper Jaffray & Co. analyst Troy Jensen points out in a brief, the company is likely to take those actions before 2006 is out.

The health of the switching business has a lot to do with Tekelec's OEM relationship with Alcatel (NYSE: ALA; Paris: CGEP:PA). “In the second quarter of 2006, revenues from our switching products decreased primarily due to decreased sales of our T8000 media gateway product (legacy Santera), particularly through Alcatel, an OEM customer,” Tekelec says in an August 9 regulatory filing.

Of the $30.7 million in switching revenue Tekelec reported for the second quarter, $19.4 million came from its Alcatel OEM sales. Alcatel’s planned merger with Lucent has given rise to some concerns about the future of Tekelec’s Alcatel connection.

Analysts are mixed on whether Tekelec can turn the switching business around.

“We believe Tekelec is committed to making switching work, despite heavy losses, and is unlikely to make major changes that could be accretive in the near-term,” CE Unterberg Towbin analyst Rich Church writes in a research note released Thursday. “We believe a significant operating model improvement in switching is still several quarters away.”

Jefferies’ Notter isn’t so optimistic. “We believe the best alternative is to sell, harvest, and/or close Switching,” he writes.

Tekelec's executives couldn't be reached for comment.

Meanwhile, Tekelec’s other businesses -- signaling gear and communications software -- look fairly solid, analysts say. “We believe Tekelec will continue to grow the company's signaling business in the near term and we expect growth of at least 10-15 percent through 2008,” Jensen says in his research note. (Tekelec’s communications software line includes call management, monitoring, and network optimization applications for carriers.)

Looking at the whole of Tekelec from an investor point of view, analysts are mainly bullish on the company. Piper's Jensen gives it an Outperform rating, while Unterberg's Church and Jefferies' Notter say Buy.

“We think there's a nice sum-of-the-parts story here,” Notter writes Thursday. “Investors are implicitly buying the Signaling business at 14x trailing earnings – plus they're getting the communications Software business for free and a free option on management's ability to extract any value from Switching.”

Tekelec Wednesday reaffirmed its full-year 2006 guidance of $525 million to $545 million in revenues, with gross margins of 48 percent to 52 percent.

The company’s stock is trading up 5 cents at $13.32 in mid-afternoon trading Thursday.

— Mark Sullivan, Reporter, Light Reading

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