Tellium Bids for $250 Million IPO

After three weeks of pumping itself up with announcements of customers, Tellium Inc. (proposed Nasdaq: TELM), an optical switch vendor based in New Jersey, today filed with the Securities and Exchange Commission to raise as much as $250 million in an initial public offering.

In the last two weeks, the startup has landed huge deals with two of the biggest carriers around: Qwest Communications International Corp. (NYSE:Q) and Cable & Wireless (NYSE: CWP) (see Is Tellium Ready for an IPO?) and (see Tellium Gets $350M C&W Deal). Clearly, these deals gave Tellium more credibility, but the S-1 filed today points to some weaknesses in the contracts.

First of all, there's the matter of Qwest and Extant as shareholders in Tellium. As part of the agreement with Qwest and Extant, the carriers both received substantial shares of pre-IPO stock in the company: 2 million and 5.2 million of them, respectively. Additionally, Qwest executives were also given a combined 333,333 shares of stock.

Additionally, the contracts have the peculiar effect of giving equity rewards to the customers for Tellium's performance.

“The warrants to purchase 2,000,000 shares were vested when we issued the warrants and become exercisable as Qwest meets specified milestones during the term of our procurement contract,” says the S-1. The fact that the shares can only be exercised as the carriers deploy equipment has surprised some analysts.

“It’s unusual to say the least, and it's sure to raise eyebrows for the appearance of impropriety,” says Chris Nicoll, VP at Current Analysis. “You’re not rewarding employees, but rather rewarding customers for continuing to buy your product.” Tellium, founded in 1997, had revenue of $5 million and losses of $19.8 million for 1999. In the six months ending in June, it increased revenues to $7.5 million, but still had losses of $19.4 million. The offering, which is expected to raise $250 million, is being led by Goldman Sachs (NYSE: GS).

Until recently, Tellium only had two customers: Extant Inc. -- bought by Dynegy Inc. (NYSE: DYN) -- and the U.S. Department of Defense. While its 512-port Aurora Optical Switch has already been shipped to Extant, Tellium has yet to realize any revenue from the product and won’t until the first quarter of 2001 (see Tellium Ups the Ante).

Other parts of the S-1 reveal that the contracts won by Tellium are full of loopholes. For example, the agreement with Cable & Wireless gives C&W the right to reduce its minimum purchase from $350 million to $200 million if Tellium doesn’t “maintain a technological edge” over its competitors. The agreement also permits C&W to terminate the agreement upon breach of a variety of unnamed obligations under the contract.

Basically, this means that C&W is not bound to the agreement, if it feels that another technology or another product is more cutting edge than the Tellium equipment. And with only three vendors signed on to even potentially contribute revenue, the loss of one contract could be devastating to the company, warns the S-1.

“There are always outs in those contracts,” says Mark Lutkowitz, president of Trans-Formation Inc., a consultancy. “I don’t believe any of these announcements until I see the product has shipped and is deployed in the network.”

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