Why Sycamore Changed Its Mind

Some months ago, while being questioned after his keynote address at the Opticon 2000 conference, Sycamore Networks Inc. (Nasdaq: SCMR) CEO Dan Smith said his firm didn't want to dabble in vendor financing. Many upstart equipment vendors probably felt it was gutsy of him to say, in effect, "No vendor should need to buy customers if it has a good product on its side." For better or worse, Sycamore's done an about-face. During its most recent quarterly earnings call, Sycamore CFO Frances Jewels said that the company had provided a vendor financing commitment of up to $200 million to two customers (see Sycamore Raises Forecasts and Sycamore Spreads Its Roots).

Only a little bit of that amount has been drawn so far, Jewels said, and it can be drawn down over a two- to three-year period. Sycamore expects that its commitments to vendor financing for the first fiscal quarter of 2001 won't reach more than $250 million.

So why did Sycamore blink? We tried to ask Dan Smith, but he wouldn't make himself available for comment. Analysts watching Sycamore, however, say the answer's simple: Sycamore had to offer vendor financing to keep up with its competitors.

"That's the name of the game now. You can't hope to play in this field if you can't offer vendor financing to your clients," says Ariane Mahler, an analyst with Dresdner Kleinwort Benson. "Carriers are all becoming more dependent on vendor financing as other avenues for financing have closed."

Whether they look to the stock, bond, or private equity markets, carriers are finding that financing network buildouts is getting tougher, especially considering how extensive these new networks must be to serve data-dependent businesses and homes. What's more, the time investors are willing to wait for a carrier to get a return on its network investment is getting shorter, too.

Indeed, according to Merrill Lynch & Co. Inc. (NYSE: MER), telecommunications companies have the highest share of the high-yield bond (or junk bond) market, which is chock full of companies that have unproven or shaky credit histories.

That's just one thing that's making investors uneasy. Recent stock market gyrations have shown that many are questioning the glowing visions of shiny new networks that they'd endorsed just a year or so ago (see Morgan Report Socks Equipment Stocks). And though venture capital investing hasn't slowed much this year, telecom VCs are unanimous in saying that they're much more selective when funding upstart carriers (see VCs Boost Optical Investments ).

With other money sources turning a cold shoulder, carriers are increasingly turning to vendors such as Sycamore to help them finance their network buildouts. In Sycamore's case, that's not such a terrible thing.

For a company with $1.5 billion in the bank, a $250 million vendor financing commitment isn't a backbreaker, especially if it gives Sycamore multiyear commitments from customers. And adding new customers to Sycamore's stable is good, because it makes Sycamore a little less beholden to its largest customer, Williams Communications Group (NYSE: WCG).

The downside here is that Sycamore is going up against Cisco Systems Inc. (Nasdaq: CSCO), Lucent Technologies Inc. (NYSE: LU), and Nortel Networks Corp. (NYSE/Toronto: NT), each of which have more financing to offer potential customers. "I don't know if it's going to work for Sycamore because everyone else can offer vendor financing, too," says Mahler. "It's a tough environment."

But even if the ability to offer vendor financing wins Sycamore a deal here and there, it won't mean much if their carrier customers can't squeeze some revenues out of their networks. In times of heightened competition and slower revenue growth for carriers, that's becoming harder and harder to do.

With the help of vendors, some carriers will turn the corner in time. Along the way, though, many carriers won't make it, and the equipment vendors propping up bad businesses will get stung (see ICG's Dark Cloud).

-- Phil Harvey, senior editor, Light Reading http://www.lightreading.com

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