Stephens 10/99 Report... interesting read.
A PairGain Win Now Seems Likely At Bell Atlantic
We have conducted more conversations about Bell Atlantic?s ongoing Request for Quote for HDSL-2 products, and we now believe that PairGain Technologies is likely to win a contract designation at the
expense of ADTRAN Inc., the current incumbent for HDSL-4.
For reasons we?ll explain below, we don?t think the win will have material impact on either Company.
We?re not changing our NEUTRAL rating on PairGain shares, but we think traders might want to buy shares pending the news, which we expect to be within two weeks. We are maintaining our BUY rating
on ADTRAN, but we wouldn?t be surprised if those shares are weak for a while.
We had been skeptical last week when a competitor declared PairGain the winner of a contract for the two-wire version of High bit rate Digital Subscriber Line equipment at Bell Atlantic. PairGain had
foreshadowed the win in the Company?s third quarter earnings conference call, telling investors the Company was close to a victory over ADTRAN and expected significant shipments in the first quarter.
We were skeptical because:
? Bell Atlantic has imposed a Y2K-related freeze on implementation of new network technology until the end of January.
? Bell Atlantic has not tested PairGain?s equipment either in its labs or in the field.
? Operations Support Systems aren?t ready for HDSL-2.
? We think Bell Atlantic?s RFQ amounts to a negotiating ploy. We believe that the carrier wants tohold HDSL-2 prices at the levels of current HDSL-4 prices and is currently engaged in a poker game
of sorts on pricing.
As a result, we did not (and still don?t) think that PairGain will ship material quantities of the technology to Bell Atlantic before the second quarter, and probably not before the third quarter. By that time, Bel?s pending merger with GTE Corp. should be complete, and we think a new Request for Quote will have been issued to suppliers. Given ADTRAN?s incumbency within Bell Atlantic for four-wire HDSL and its very strong relationship with GTE, we think it will ultimately keep the business at the merged entity.
Nevertheless, we do expect a press release from Bell Atlantic designating PairGain as primary HDSL-2 supplier there, and we think it?s likely the news will pressure the stock of ADTRAN and burst the stock of PairGain, at least in the short term.
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Stephens 2/24/99 Report
ADC Telecommunications announced it will acquire PairGain Technologies in a stock pooling valued at $1.5 billion based on Wednesday?s closing price for ADC. The exchange ratio is 0.43 ADC shares per share of PairGain, with no collars and a breakup fee of approximately 3% of the value of the transaction,
which is scheduled to close in July.
We are raising our rating on PairGain shares to BUY, with a one-year target of $34. The rating and target are based on our BUY rating of ADC Telecommunications, and our one-year price target of $79,
multiplied by the exchange ratio established in the acquisition agreement.
We think the deal is slightly positive for ADC, which will acquire PairGain?s engineering team and its Avidia digital subscriber line access multiplexer platform, along with the Company?s High bit rate
Digital Subscriber Line (HDSL) and subscriber loop carrier businesses. Given the cost synergies available as duplicative functions are eliminated, the deal should pay for itself over time from ADC?s perspective.
More importantly, the transaction will keep PairGain?s DSL assets, sales force and account relationships out of the hands of the many new entrants to the access concentrator and copper transport sectors, thereby helping protect ADC?s Soneplex platform from rising competitive pressure. As a defensive move, we believe the acquisition makes sense for ADC, which along with PairGain has been facing increased pressure in the HDSL arena from ADTRAN Inc.
The acquisition should be marginally effective in strengthening the pricing environment for HDSL and forthcoming HDSL-2 products, as well. Signs had been accumulating that PairGain was getting ready to
launch a pricing offensive in the HDSL-2 arena in a last-ditch attempt to win business at Regional Bell accounts that had switched from its HDSL products to those made by ADTRAN. The ADC acquisition makes a pricing battle somewhat less likely.On the product front, we continue to believe that ADTRAN maintains a significant and growing
advantage over both PairGain and ADC in the HDSL arena. If anything, the acquisition is likely, in our view, to reduce ADC?s progress in the sector as it pauses to harmonize its access platform with PairGain?s. In the meantime, we believe ADTRAN is seeing increasing success with its Total Access and Atlas access concentrator architecture.
Prior to the deal?s closing, PairGain and ADC will continue to sell separately into the market, although with reduced credibility for PairGain given that the two companies base their HDSL efforts, and particularly their HDSL-2 efforts, on different chipsets. We believe that PairGain?s progress in selling HDSL-2 to Bell Atlantic has been stalled by performance problems with its chipset supplied by Intel?s
LevelOne division.
In short, we believe the ADC-PairGain deal will end up preserving the combined entity as a secondary supplier of HDSL and HDSL-2 products to Regional Bell customers, likely keeping other suppliers from gaining much of a presence in the market. ADTRAN, in our view, is firmly in place as the leader, and we think its primary status will remain unaffected by the transition.
With respect to PairGain?s Avidia and FlexPlus products, we believe the outlooks for both platforms are uncertain. While billed as a multiservice access concentrator, Avidia has been deployed solely as an Asymmetric Digital Subscriber Line DSLAM, mostly in trials. Its future as a full-fledged access concentrator is unknown, although we have heard much praise for its architecture among engineers. The
major deals hinted by the Company and touted by its constituency among investment banking analysts have not yet materialized.
As for FlexPlus, we think it?s only a matter of time until other vendors enter the market for span-powered, low-end digital loop carriers. We have seen some competitive products, and discussed others, and therefore expect what will be the PairGain division of ADC to face increasing competition in this segment of its business.
Prior to the deal, PairGain had $2.81 per share in cash on its balance sheet. The recently announced acquisition of its chip development unit by GlobeSpan Inc. added a note worth $1.27 per share, and 1.1 million shares of GlobeSpan stock currently (and exuberantly, we might add) valued at $3.44 per share.
This implicitly values the Avidia, HDSL and subscriber loop businesses, and the PairGain personnel at $11.40 per share, or $811 million.
Ordinarily, we might say this is on the high side. After all, PairGain has been troubled for quite some time and the Company could be termed a motivated seller. Still the ongoing unit growth in HDSL sales, along with the moderation of price competition and the blocking impact on new competitors, should make the acquisition a reasonable, if not terribly material, move for ADC and should, in our view, be greeted fairly positively by shareholders.
We would make one other point, which is that we see the acquisition is part of an ongoing consolidation within the Local Loop access space, as entities face increasing pressure to meet escalating price-performance standards demanded by an ever more competitive telecommunications industry. No one who follows telecommunications service providers can escape the message being sent by those stocks, which are increasingly burdened by worries over escalating competitive pressures.
When airlines were deregulated in the 1980s, they eliminated a wide range of perks to save money. As telecom providers head into a free market, we expect them to scrutinize costs more closely than ever
before, especially in product categories that have become commodities. This is what ultimately compelled PairGain?s sale and, in our view, will continue to drive consolidation in the access equipment sector. |
