Tellium Takeover Plan Brewing

With the 2002 fourth quarter earnings announcement of optical switch maker Tellium Inc. (Nasdaq: TELM) two weeks off, investors are getting restless and there is talk of a takeover bid by a private firm looking to liquidate the company.

A New York-based private equity firm with over $40 million under management says that it is putting together a proposal to buy Tellium. It then plans to sell all the company’s assets, in an effort to return shareholder investments.

This firm, which spoke to Light Reading on condition of remaining unnamed, says it has recently been buying shares in the company in preparation for a takeover. While the firm hasn’t officially approached Tellium with a deal yet, it says the company is ripe for liquidation.

The strategy has plenty of holes in it. First of all, $40 million is not a lot of money (relatively speaking), and it would be difficult for a small player without a big reputation to convince shareholders a buyout would be in their best interest. Tellium currently has a market capitalization of $70 million.

But some investors say their ears are open -- and they appear to be running low on patience. One European fund manager, whose combined client investment in Tellium makes him among the top ten investors in the company, says he thinks liquidation is the only option at this point.

“I think the company’s management has lost credibility,” says the investor, speaking under condition of not being named. “They are always promising new business and never delivering. The company has no right to be in existence. It is just burning through cash that we put up.”

David Jackson, formerly an equities analyst with Morgan Stanley, who is now looking to start his own hedge fund, says that Tellium is in a particularly difficult position because its product requires carriers to change their architectures from a ring topology to a meshed topology.

"Big architectural projects like that have been put on the back burner," he says. "This means that for Tellium the medium- to long-term outlook looks bad, because no one is taking on big projects like this. The big question now becomes: How long do you wait for the market to turn around while the company continues to burn cash?"

That's precisely the question investors are asking. The company has made some strides in reducing its cash burn rate, including enacting several rounds of layoffs -- the most recent one having been announced last week (see Tellium Lays Off 130 and Tellium Wields the Axe).

Tellium, like other bubble-era companies, raised a large amount of cash during its initial public offering (IPO) in the spring of 2001 (see Market Gives Tellium a High Five). Since then, however, it has failed to generate much revenue and has continued to mount losses. In the third quarter of 2002, it brought in just $1.5 million in revenue and recorded a $17.4 million loss (see Tellium Reports Q3). It currently has about $183 million in cash, having spent $22.9 million during the quarter. Its stock price is currently about $0.60 per share.

The company has struggled to win new customers, and its outlook for 2003 continues to be bleak. Only two carriers -- Dynegy Inc. (NYSE: DYN) and Qwest Communications International Inc. (NYSE: Q) -- generated revenue for Tellium in the first nine months of 2002, according to its last quarterly filing with the Securities and Exchange Commission (SEC).

In December of 2001, Qwest modified its original $300 million contract with the company (see Qwest and Tellium Revise Contract). The carrier is not expected to generate much, if any, revenue for Tellium in 2003. Tellium's relationship with Qwest, incidentally, has been the subject of scrutiny from a number of recent shareholder class action suits, accusing executives of the two companies of some underhanded dealing (see Tellium Lawsuits Allege Rigged IPO).

Tellium also recently amended its $350 million contract with Cable & Wireless (NYSE: CWP) (see C&W, Tellium Rework Contract). The carrier has agreed to purchase a minimal amount of gear in the first half of the year, but is not required to make any additional purchases.

Some shareholders, like the European fund manager, say they are ready to throw in the towel. They are frustrated with Tellium's lack of customer traction, and they want their money back.

Tellium did not respond to Light Reading's requests for comment, but Bill Roper, a member of Tellium's board and executive vice president at Science Applications International Corp. (SAIC), had something to say.

He wouldn’t answer specific questions about selling or liquidating the company. But he did comment generally about his responsibilities as a board member.

"If a significant proportion of the shareholder base has important input on strategy or direction for the company, I think it’s incumbent on the board to listen to that input and give it fair hearing," he says.

Tellium isn’t the only company in the industry that is being sized up for liquidation. CoSine Communications Inc. (Nasdaq: COSN) last month rejected two offers from Wyndcrest Holdings LLC, a private venture firm based in Florida (see Floridians Bid for CoSine ). Other companies such as Corvis Corp. (Nasdaq: CORV) and Sycamore Networks Inc. (Nasdaq: SCMR) are also potential targets, says David Jackson. Sycamore has $1.02 billion in cash and investments and had revenues of only $5.9 million last quarter (see Sycamore Reports Q1). Net loss for the first quarter of fiscal 2003, on a GAAP basis, was $17.4 million. Corvis, meanwhile, has $548.7 million in cash and brought in just $1.4 million in revenue last quarter (see Corvis Reports Tiny Revenues). Its losses were $127.4 million.

"I think we will definitely see a lot more of this kind of activity in 2003," says Jackson. "Investors are increasingly growing more impatient with these small-cap companies. They are no longer growth investors and are now more interested in value."

Liquidating a company is no easy task. If the board rejects a bid from a private group of investors, shareholders have little recourse unless they can rally the support of larger investors. A private firm could take over a company by purchasing enough shares from the largest stakeholders to gain majority ownership in the company. At that point, they could vote in a new board of directors, who in turn could make the decision to liquidate and disperse cash to shareholders.

— Marguerite Reardon, Senior Editor, Light Reading
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DoTheMath 12/5/2012 | 12:51:13 AM
re: Tellium Takeover Plan Brewing From an overall economic standpoint, liquidating the
bad investments of the bubble era is exactly the
right idea. Capitalist system makes mistakes, but the key
to its vitality is the ability to correct and learn
from mistakes.

There are any number of "zombie companies" (a term
much in vogue in Japan), which have no real prospects
but who hoard huge amounts of capital. I bet if
you add up the total cash piled up in Nasdaq companies
that are trading below cash, you will find billions
in "zombie capital". This capital legitimately belongs
to the shareholder, and the companies have proved
themselves utterly incapable of deploying it profitably.
Now they are busy destroying that capital.

But the economic losses don't stop with the loss of
capital. The people employoed by these zombie companies
are mostly going through the motions until the
inevitable happens. Their talents and efforts are
utterly wasted, and they actually become more
unemployable due to years of make-work projects.

For those who need a primer on this, Japan in the 90s
is a classic illustration. Their system has proved
itself incapable of shutting down zombie companies -
indeed they have funnelled more bank loans and taxpayer
subsidies to zombies in a vain effort to keep them
alive - and the result after 10 years is an utter
societal crisis.

The public sector companies in socialist countries
have been on the same trajectory, with similarly poor
results. Making the mistake of funding these companies
is not the problem, refusing the correct the mistake
is utter folly.

One of my friends recently lost his job at a zombine
company, and the fact is he feels utterly liberated, after
more than a year of "wait and see". That tension was
more painful than finally getting fired, and he is already
thinking up creative ways to make it. Since he saved up
well, I am confident he will figure something to do. Truth
is most people, if only they applied their minds,
will figure something out. That is the magic of a
free system.
steve 12/5/2012 | 12:51:13 AM
re: Tellium Takeover Plan Brewing Careful there LR, you are getting schooled.

No self respecting buyout guy is going to announce to you, or anyone else, that he is preparing a bid, accumulating stock, etc. Why would he want to leak it and drive the stock price up???

You are getting taken advantage of by someone who has already established their position and just wants to get a quick pop, or is trying to get someone else to do the heavy lifting.

For all the moralizing LR does on shady stock deals, you have just helped out on one!!
zettabit 12/5/2012 | 12:51:12 AM
re: Tellium Takeover Plan Brewing It is finally happening.

Given that Tellium's market cap is worth less than half its cash on hand, and with its non-existant prospects for meaningfully increasing its revenue in the next 12-18 months, this is the only thing that makes sense.

Let's look at the facts:

- Dynergy network build is done. With Dynergy a tier-2 player whose carrier business is barely tenable itself, they will not be expanding anytime soon.

- Qwest business was a one-time "get this off our books" deal so that Qwest could live up to its part of the deal when it got stock warrants from the Tellium IPO. Otherwise Qwest's core switch is CoreDirector which is not yet fully utilized, and their network growth will not justify more deployments of OXC for a while also.

- Cable & Wireless contract was exposed as the fraud it was when it was renogotiated. C&W has deployed CoreDirector everywhere, it is very under-utilized, and they have slashed their CAPEX so much that even if Tellium got a piece it would be tiny amounts of $.

- The "rumours" of a potential deal with Deutsche Telecom was just unethical market hype put out by Tellium themselves to stabilize their stock price, and will never materialize as DT has selected and deployed Lambda Unite from Lucent.

And there is nobody else even remotely on the horizon as a potential customer for Tellium.

Once you back off severance pay, lease commitments, etc... , and add in whatever assests can be sold at auction, the shareholders will still get a cash distribution that I estimate will be worth about 50% more than Tellium's current market cap.

And there's even upside to that - maybe they can be paid back the loan amounts that Tellium made to its executives to buy their stock pre-IPO.

Too bad this can't happen to Corvis as well. They are in the same boat, except that Huber has a controlling stake to block such a move.
kampar 12/5/2012 | 12:51:11 AM
re: Tellium Takeover Plan Brewing
>Careful there LR, you are getting schooled.

>No self respecting buyout guy is going to
>announce to you, or anyone else, that he is
>preparing a bid, accumulating stock, etc. Why
>would he want to leak it and drive the stock
>price up???

Taken a look at Cosine recently (COSN)? This is pretty much the same story as LR reported at Tellium except ... this is a public run at the company for apparently the same reason - buy it, take a cut of the cash and liquidate the rest.

gzkom 12/5/2012 | 12:51:10 AM
re: Tellium Takeover Plan Brewing The earlier the massive merge/liquidation happen, the more beneficial to the economy, the industry, shareholders, and the employees GÇô the employees who left or laid off early got good surveillance package and found better jobs while the employees wait until the last days often got very little.

Actually, the best approach is self-liquidation by the board- shareholders-executives.

For example, with $183 million cash, TELM has a cash value of $1.60/share. However, TELM could announce a $50 million stock buyback plan, and then quietly purchases its own shares at $1 each on average. When the purchase is complete, TELM will still have $133 million cash in hand, while there are only 64 million shares outstanding. Then, if the board/shareholders/executives agree to shut down the company, and sell its asset for $20 million (10 cents for each dollar of asset/equipment/plants/inventory value), each share is worth about $2.40.

Sounds like a better GÇ£dealGÇ¥?

It's not easy, but certainly doable. The only resistance is the executivesGÇÖ ego and self-interests.

I wonder why this kind of self-liquidation has yet to happen.
kampar 12/5/2012 | 12:51:10 AM
re: Tellium Takeover Plan Brewing
Okay - so I just read to the bottom of the article and saw the Cosine reference. Ahem.

BlueWater66 12/5/2012 | 12:51:02 AM
re: Tellium Takeover Plan Brewing If the shareholders want some of the money back, they should push for a dividend. Who knows, might even be tax free!

The LBO guys won't return much money to the shareholders. Their aim is to buy the company cheap and liquidate the assets. They will then keep the difference. It is assumed that towards the end of their "acquiring shares" process, the value of the shares would approach the cash value of the company. But- most of the existing investors would not fully benefit from this.

BTW: I complete agree with the first positing. A real LBO company (like KKR) would never do this. Plus, it takes serious amounts of money to be a player in the LBO market. Most of the funds are quite large. $40M isn't even enough to qualify as a Tier 3 seed venture fund.
Litewave 12/5/2012 | 12:50:45 AM
re: Tellium Takeover Plan Brewing when you need him to comment? ;)
twistedcopper 12/5/2012 | 12:50:33 AM
re: Tellium Takeover Plan Brewing litewave,
i was out of commission for a few days and didn't see this article until i got in to work about ten minutes ago. my thoughts:
liquidating the company is not going to get the shares back up to $10 (which is about the lowest offer i would consider) and i think someone would have to be insane to sell at the prices i've seen in some of these earlier messages. bottom line is that TELM is still the leader in core grooming switches and it's going to be a major player when the market comes back in june (or maybe july at the latest). harry carr is a smart guy who will pressure some big carriers out there to build out their networks... my prediction: we're not far from another $350M contract to replace c&w (those guys need to learn how to stomach a downturn).
to all you TELM shareholders out there-- trust me, this stock will see all-time highs by the end of 2003.
TELM to $100!!!!!!!!! (gotta be ambitious in these bleak times.)
pipesoflight 12/5/2012 | 12:50:33 AM
re: Tellium Takeover Plan Brewing So how will the current set of class action suits against Tellium turn out? Predictions?
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