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Hazy Atmosphere Hangs Over Ditech

Buying off the bargain rack doesn't always mean you get the best deal. That’s what Ditech Communications Corp. (Nasdaq: DITC) is figuring out.

The company, which was formed in 1987 and builds high-capacity echo cancellers and optical subsystems, bought optical startup Atmosphere Networks in June for the low, low price of $85 million in stock and $10 million in cash, as a way to boost its presence in optical networking (see Atmosphere Comes Back to Earth). But since the acquisition, Ditech stock has lost about 35 percent of its value.

“Its been a rough market for a lot of folks,” says Tim Savageaux, research analyst with W.R. Hambrecht & Co. “But the Atmosphere acquisition may have also adversely affected the stock.”

When news first broke that Atmosphere was looking to be sold, no buyers were coming forward. The main reason is that the company bet on the wrong technology. It focused on ATM-based Sonet while the rest of the industry was leaning toward Internet Protocol (IP). After trying to reinvent themselves and failing, the company was forced to look for a buyer and get what they could out of the deal (see Atmosphere On The Block? ).

“I think Ditech sort of assumed that buying anything in the optical space would be perceived positively,” says Savageux. “But investors have looked at the price, and when some companies are being sold for $4 billion, $80 million looks pretty low. They might be thinking that they got what they paid for.”

But Ditech says it didn’t buy Atmosphere for its product; it bought them for the 55 employees they added to the 140 people already working at Ditech.

“Mostly we bought them for their engineers and the expertise they bring to Ditech,” says Kim Shanley, VP of communications at Ditech. “We still don’t know for sure what we are going to do with the Atmosphere product.”

Ditech remains tight-lipped about its exact plans, but Shanley says that it’s working on system-level products that will be introduced sometime next year. While the company plans to continue its subsystem business, it says it will focus on the higher margin, higher-level products.

Even if the company wanted to change directions, why would it buy Atmosphere? The main reason is that it was cheap. With less than a $2 billion market cap, Ditech doesn't have too many choices when it comes to trading its stock for acquisitions. Unlike a successful company with a high-flying stock price like Sycamore Networks Inc. (Nasdaq: SCMR), which could easily afford a high-profile startup like Sirocco Systems, Ditech had to look for bargains.

“Were they affordable? Yes,” says Shanley. “That plays into the decision making process. We are a relatively small company and a $7 billion or $10 billion deal for a startup is not something we could hope to do.”

The company will announce its first-quarter earnings on August 17.

-- Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com

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