thanks, brien.
for what it's worth, TLAB makes SmartMoney's daily screen.
just the messenger,
-chris.
-----
October 7, 1999
Hanging in the Balance
By Alec Appelbaum
A BALANCE SHEET is a snapshot of a company's assets and liabilities at a moment in time. For today's screen, we turned up a company with a healthy balance sheet and an uncertain future. We submit it for your approval as an example of how a strong balance sheet can reveal the potential for strong competitive moves.
We weren't too surprised to find Tellabs (TLAB), a onetime SmartMoney pick, since it enjoys a strong reputation for engineering smarts and fiscal prudence. We were a little leery at first about profiling the company right now, because it's nowhere near the market lead in telecommunications equipment, and its rivals get bigger every month. Are strong balance sheets enough to predict long-term performance in a world where size definitely matters?
Tellabs' strength is in making small, cheap machines to help phone companies transfer optical signals from recently built long-distance fiber lines onto older copper local lines that use electrical signals. But because light moves faster than electronics, all carriers want to be able to deliver as much information as they can in the form of light. Market leaders like Cisco Systems (CSCO), Nortel Networks (NT) and Lucent Technologies (LU) are buying and tinkering to build "pure optical" technologies -- lines and computers that carry light from one source to another without ever slowing down to translate that light into electronics. Since Tellabs makes machines that translate light into electronics, you might well worry.
But in Tellabs' solid health may rest its salvation. We found Tellabs by looking for companies that could go it alone, with lots of cash, little debt and low levels of preferred equity. Companies, in other words, that will be able to keep investing in their businesses even if the Federal Open Market Committee or the stock-investing public made the capital markets a less friendly source of new money. Happily, Tellabs is spending as we speak.
This past Tuesday it announced plans to spend $75 million on a new 2,300-employee facility in its Illinois home base. More generally, it's investing in new network products while tending to its bread and butter, the cross-connect. Basically, a cross-connect takes light and converts it into electronics, and a good cross-connect does this reliably and cheaply even if a lot of information is feeding into it at the same time. Cisco and Nortel have made splashy announcements about their plans to eliminate the need for electronics and deliver all information as light. Quietly, Tellabs' new box, the Titan 6100, makes a similar claim: It offers slots and configurations that can run optical signals or convert them, depending on what's called for.
Analysts say this product, available later this year, should serve much the same purpose as Cisco's and Nortel's "pure optic" boxes slated to arrive late next year. If Tellabs has the goods, why has its stock been sagging since midsummer? Partly, says Volpe Brown Whelan analyst Tim Savageaux, a slowdown in announcements and hubbub creates few reasons to buy into Tellabs right now. More generally, the company simply doesn't have the advantage of size. The statistical dropoff in revenues between the big three and other telecom equipment companies is alarming. According to Jim Parmelee of Credit Suisse First Boston, Lucent led all networking companies in market-share gains during the first six months of this year. It picked up 2.17%. Tellabs was fourth with a gain of nineteen hundredths of a percent.
How can Tellabs keep from getting trampled in this stampede? Remember how we started: the balance sheet. As a niche player, says Wall Street Journal All-Star analyst Patrick Houghton of Sutro & Co., Tellabs is more likely to increase its revenue base by improving its product line than by moving into completely new product areas. That means it can invest cash in research and development instead of raising debt for experimental approaches. Lucent and Cisco tend to engage in "customer financing," in which they issue bonds or draw on credit lines to help service providers afford expensive and innovative equipment. Tellabs, on the other hand, typically invests an above-average 13% of its revenue in research and development, says spokeswoman Jean Medina.
According to Dataquest's Tim Smith, Tellabs should use its ample cash and R&D budget to buy hot startups. That's much easier said than spent, since it takes a gambler's nerve to buy startups in the networking business these days. Cisco's recent spree and Lucent Technologies' $900 million buyout of Nexabit, which had a promising idea but no products shipping, has raised startups' asking price to nausea-inducing heights. Tellabs' strong balance sheet can fund acquisitions of promising startups, but it also reflects the company's historically cautious approach -- an approach that now seems oddball in the networking world.
That approach may be changing. The company recently closed on the purchase of NetCore, whose box reads Internet traffic using high-speed protocols and then routes that traffic using a popular digital format. Tellabs paid $575 million in stock for that company, which may seem like chump change compared with the $7 billion Cisco spent to acquire optical specialists Monterey Networks and Cerent. But according to Sutro's Houghton, the box gives telecom carriers a way to take on more broadband data traffic and manage the voice traffic that accounts for 90% of their current revenue.
More deals could be on the way, but Tellabs isn't likely to go completely merger-mad. The collapse of its merger with data-multiplexing pioneer Ciena (CIEN) last fall probably made the company a bit gun-shy. Still, Mat Steinberg, director of optical networking at research firm RHK, sees the NetCore deal as a sign that Tellabs is getting bolder; it even told investors to expecta one-to-two-cent earnings dilution this year without blinking. But Dataquest's Smith says CEO Michael Birck better have more bravado, since pushing NetCore past the leaders in customers' minds will take a lot of ingenuity and spending.
In the end, the balance sheet is just a resource that Tellabs managers need to exploit. Encouragingly, the company is well-liked by Wall Street types and industry researchers. Smith says its focus on efficiency and economy commands great respect among customers. But Smith also views the networking marketplace as "full of black holes" -- companies so big and dominating that they suck in everything around them. Tellabs' only problem is that it's trapped in a universe it never made, where bigger companies fight furiously for its customers and spend lavishly to buy equal technologies.
And even the heft of a healthy balance sheet can't always resist the vortex of a black hole.
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