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Wall Street Frets About BellSouth Suppliers

It's been almost a year since the announcement that AT&T Inc. (NYSE: T) and BellSouth Corp. (NYSE: BLS) would join together in a $67 billion merger. To equipment vendors like Adtran Inc. (Nasdaq: ADTN), Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA), Redback Networks Inc. , and Alcatel-Lucent (NYSE: ALU), however, it has seemed like a lot longer.

Will the fortunes of equipment suppliers to the two large RBOCs improve now that the FCC unanimously approved the merger? (See AT&T, BellSouth Merge.) Analysts appear split on the issue, setting up for a year of uncertainty and potential stock volatility.

The short story: Equipment vendors that depend heavily on AT&T for revenue -- such as Alcatel-Lucent and Adtran -- are in much better shape than vendors heavily dependent on BellSouth, including Redback and Tellabs.

Since the AT&T/BellSouth deal was announced in early March 2006, many equipment companies -- and investors -- have been waiting to see what effect it would have on capital spending, particularly in BellSouth's region. (See Will AT&T Value BellSouth's Vendors?) With the delays in getting FCC approval that followed, equipment spending from both companies dropped off as the uncertainty of their futures loomed.

The direct effect on equipment vendors was seen this week when both Tellabs and Redback -- which each have high exposure to BellSouth -- pre-announced disappointing fourth-quarter earnings. (See Redback Lowers Guidance and Tellabs Estimates Q4.) Both companies cited the merger in their releases as one reason for their shortfalls.

To figure out what comes next, there are a number of things to consider. For one, FCC approval came only after AT&T agreed to several key concessions, one of which was that broadband service must be deployed in 100 percent of the combined AT&T/BellSouth territory by December 31, 2007. The requisite spending increase should greatly benefit the DSL equipment vendors.

"While these broadband coverage requirements were in prior iterations of AT&T/BellSouth's proposed merger concessions, they suggest that the combined entity still has to push additional DSL services out there," wrote Jefferies & Company Inc. analyst George Notter in a research brief earlier this week. "In our view, this is positive for Alcatel-Lucent and Adtran -- the incumbent DSLAM vendors."

Notter pointed out that prior to the merger, AT&T accounted for 4 to 6 percent of Alcatel-Lucent's total sales and 18 percent of Adtran's third-quarter sales. Historically, AT&T has imposed its own technology on companies it has acquired. That's good news for a vendor that relies so heavily on a single company's business.

While it appears that AT&T's vendors are in good shape for 2007, uncertainty remains with those more dependent on BellSouth. "The biggest thing to look for in Tellabs' case is that they generate about $200 million in access equipment sales from BellSouth," said Joe Chiasson of Susquehanna Financial Group when reached for opinion. Any disturbance in BellSouth's network infrastructure could put a dent in Tellabs' revenues -- and AT&T and BellSouth are currently not compatible. "The biggest thing to look at is that the FTTC technology is at odds with what is going on in the SBC legacy where they use FTTN. So you've got to look at it and see the inconsistency," notes Chiasson.

It raises the question of whether AT&T will impose its own infrastructure in the BellSouth regions. "What's also going to be important for Tellabs is, it looks like for 2007, there won't be any change in architectures. What happens beyond that, it is hard to say," says UBS AG analyst Nikos Theodosopoulos.

Bottom line? AT&T's incumbent vendors appear to be safe as the company is prepared to return to its normal spending levels. BellSouth's primary vendors, on the other hand, have their work cut out for them in 2007 and 2008.

— Raymond McConville, Reporter, Light Reading

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