Dow Jones Newswires
TALES OF THE TAPE: Tellabs, Ciena Heal From Dead
Deal
By SHAWN YOUNG
NEW YORK -- It was kind of a Wall Street version of the excruciating slow-speed chase by Los
Angeles police of a certain Ford Bronco a few years back.
Granted, no crime had been committed. But when it was over, the financially wounded ranged from
a retired elevator repairman in the Bronx to the mammoth Long-Term Capital Management LP
hedge fund, which nearly went broke and had to be bailed out for $3.6 billion.
What Long-Term Capital and the elevator mechanic had in common about a year ago were
investments in a planned $7 billion merger between two telecommunications equipment makers,
Ciena Corp. (CIEN) of Linthicum, Md., and Tellabs Inc. (TLAB) of Lisle, Ill.
That deal collapsed in surreal slow motion. By the fall, Ciena had lost nine-tenths of its market
value, Tellabs two-thirds. Since then, both stocks have roughly quadrupled. But while Tellabs'
shares have gone on to new highs, Ciena's stock remains more than 60% below its peak of 92 3/8,
reached July 21, 1998.
Ciena's top stock price was inflated and a little misleading because it was fueled by the
then-pending takeover, said Jae Lee, an analyst for American Express Financial Advisers.
The merger was supposed to marry Ciena's hot new products with Tellabs' roster of customers,
giving Ciena a much bigger foothold in the market and helping Tellabs' stay on the cutting edge.
There is no doubt that Ciena is doing much better than it was last fall, but don't expect its stock to
recover its full glory anytime soon, analysts and investors say. The high was particular to its time
and takeover, they say.
"To achieve that on fundamentals would take some time," said Ophelia Barsketis, senior vice
president and fund manager at Stein Roe & Farnham Inc.
"To have that revisit the company twice is kind of like getting hit by lightening twice," Barsektis said.
Not that the company isn't trying.
CEO Says Ciena Learned Hard Lesson, Regained Its Footing
"I think things worked out for the best in a lot of ways," Chief Executive Patrick Nettles told Dow
Jones Newswires. "We've learned a lot."
Ciena has broadened its customer base and made progress repairing its damaged margins. It also
has improved its products and spent nearly $1 billion on two important acquisitions.
"They do have excellent technology, that's never been a question," Lee said. "It's just who they are
competing against."
Ciena was the early leader in a technology called wave-division multiplexing that boosts the
capacity of fiber optic lines, but powerful competitors, including Lucent Technologies Inc. (LU) and
Nortel Networks Corp. (NT), moved quickly.
Ciena ended up paying dearly for its dependence on just a handful of customers, which early on
had included Sprint Corp. (FON) and MCI WorldCom Inc. (WCOM).
"We in some sense were blinded by our early success with Sprint and WorldCom," Nettles said.
"We've shifted our emphasis over the last year."
With the acquisitions of Omnia Communications Inc. and Lightera Networks Inc., both privately
held, Ciena is adding capabilities to its products that will help repair margins, Nettles said. It also is
seeking work from the many upstart carriers that are building cutting-edge fiber optic networks.
The company now has about 20 customers, more than twice as many as last year, he said.
"You really can measure the resilience of an organization by how it deals with adversity," Nettles
said. "We did lose some focus in the course of the merger discussions. We had a painful
education."
From an earnings perspective, the pain isn't over. The company is expected to report a fiscal
third-quarter loss of 1 cent a diluted share later this month, compared with a 15-cent profit a year
ago.
Ciena's profit decline began in earnest around this time last year, when it warned that fiscal
third-quarter earnings would fall at least 50% short of expectations.
That proved to be only the first catastrophe in a meteor shower of bad news from Ciena that by
mid-September had undone the merger deal.
"It was one of the weirdest things I've ever been through," said Doug MacKay, manager of Oak
Associates Ltd. Red Oak Technology Select Fund. Oak remains a major investor in Ciena and
also held onto a position in Tellabs, which it has expanded over the past year.
Like virtually every other investor, MacKay thought about selling. He stayed in the stock, he said,
because "we thought it was way overdone on the downside."
"We never really got the sense that Ciena was losing market share. We didn't see a real change in
the market, and we still saw them getting a good share of a growing pie," MacKay said.
Now things in general are improving and the company has stabilized, making results easier to
understand and predict, he said.
To some, the past year is little more than a closed chapter in Ciena's history, but skeptics remain.
"In my mind it is overvalued and expensive at this point," said Volpe Brown Whelan analyst
Timothy Savageaux. "The stock suggests a rosier outlook than is warranted."
"The company has a guidance track record which is mixed," he said.
After Rough Spell, Tellabs Looks Robust
Tellabs' shares have cooled from a recent 52-week high, but even analysts like Savageaux, who
thinks the stock is due for a pause, find little to criticize.
"After being dazed for a month or two, they really came together," Savageaux said.
Tellabs had come into the Ciena deal with a sterling reputation. Its management team is still
regarded as top notch.
"That's the real reason to own the stock," said Barsketis of Stein Roe & Farnham, who invests in
Tellabs.
"We did have quite a period of 'Oh dear, what's going on here?" she said, but the company's track
record prevailed. "It was prudent to give them the benefit of the doubt," Barsketis said.
After all, said Lee of American Express Financial Advisers, things fell apart very quickly and in
ways that couldn't reasonably have been predicted.
In the wake of the deal, Tellabs, like its former partner, has gone on to make acquisitions. Tellabs
plans to spend $685 million buying privately held NetCore Systems Inc. and a small unit from
Alcatel SA (ALA).
"They are getting exactly what people criticized them for not having," said Robinson-Humphrey Co.
analyst Greg Mesniaeff. That is, technology for the new generation of voice and data networks.
Meanwhile, earnings have soared. Excluding one-time items, Tellabs said operating profit rose 48%
in the second quarter for which it recently reported earnings.
The challenges for Tellabs include weak second-quarter sales of one important product and broad
market trends that encourage price competition and are creating a new class of less wealthy upstart
customers.
Few seem to doubt that the company can handle the changes.
"I think they have a clear road map," said Mesniaeff, who thinks it is to the credit of both Tellabs
and Ciena that they don't need each other as they thought they did a year ago.
It's unlikely that the companies would reopen talks, he said. "The well has been poisoned."
To be sure, the collapse of the merger hurt the credibility of both companies and cost investors a
fortune.
But to Basketis, Tellabs' decision to endure the market's wrath and walk away is to its credit.
"The real hard medicine sometimes is to admit that you've made a mistake," she said. "You have to
have strong management, a strong board and a strong stomach."
- By Shawn Young; 201-938-5248 shawn.young@dowjones.com
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