From RedHerring.com:
redherring.com
IPO Critic: Tellium's long journey is just beginning
By Stephen Lacey
Red Herring
May 4, 2001
By all indications, Tellium (proposed Nasdaq: TELM) is like a fish swimming upstream. For starters, telecommunications carriers are slashing cap-ex budgets. In light of that, Tellium management admits that the company's huge net losses will continue. Furthermore, the markets are having a tough time digesting already public optical networking companies -- they'll be hard pressed to absorb another.
Yet after a March move to switch lead underwriters to Morgan Stanley from Goldman Sachs, Tellium CEO Harry J. Carr is on a cross-country roadshow to drum up support for the company's $105 million IPO. Despite Mr. Carr's pedigree -- the former AT&T executive was at the helm at Yurie Systems when Lucent Technologies (NYSE: LU) acquired the switch manufacturer for $1 billion in 1998 -- his latest venture could be his greatest challenge.
After luring Mr. Carr away from Lucent in December 1999 with options to buy 13.2 million shares -- 7 percent of the company -- for $1.07 per share, the Oceanport, New Jersey-based company had little trouble raising $222 million in September 2000. There were 57 institutions that bought in at levels comparable to the company's original $2.9 billion IPO valuation.
But September was a long time ago. After a reverse two-for-one stock split in April and after burning through $60 million since the last infusion, Tellium is now marketing itself to investors at a $1.5 billion market capitalization. Joint book managers Morgan Stanley and Thomas Weisel Partners are looking to price 7.5 million shares at $13 to $15 per share the week of May 14.
The decision to go forward with the IPO screams of desperation similar to that of Agere Systems (NYSE: AGR.A), another Morgan client that was forced to slash its IPO price to $6 per share, a 60 percent discount to what Lucent originally had sought for the unit. The buy-side can smell blood and will likely take advantage of Tellium at its pricing date.
So why would Tellium management elect to go forward with the offering when it still has $166 million in the bank? One possible explanation could come from the nature of the September private round. As part of the original financing agreement, these Series E preferred stockholders will be made whole, regardless of where the company prices its IPO. At $14 per share, the midpoint of the offering price, their original investment is convertible into the same 15.6 million shares despite the reverse two-for-one split, essentially doubling their ownership stake to 14.3 percent.
THE LONG HAUL
The real answer, however, may lie in Tellium's focus on optical switch products for long-haul networks. The second generation of its Aurora optical switch, which began shipping in the third quarter of 2000, uses software that enables carriers to upgrade their networks more rapidly between the major hubs that connect cities. By intentionally ignoring the switching of optical signals in the DS-1 (1.5 Mbps) and DS-3 (45 Mbps) levels used within metropolitan networks, Tellium has become a leader in the OC-48 (2.5 Gbps) switch market.
"As you look into the future, these types of switches have a place in the market because of the huge amount of data that's being carried," says Sam Greenholtz, a senior optical networking analyst with Communication Industry Researchers, a Charlottesville, Virginia, optical industry consulting firm. But because its switches can't groom signals down to lower speeds, where many carriers are concentrating their expenditures, the long-term strategy has cost it over the short term.
The problem is that Tellium hasn't been able to attract many buyers for its long-haul switches. Dynegy Connect, a Dynegy (NYSE: DYN) subsidiary, accounted for 70 percent of the $15.6 million in sales the company generated in the first quarter, while Qwest Communications (NYSE: Q) accounted for the remaining 30 percent. In September 1999, Dynegy Connect agreed to purchase $250 million in Tellium gear over the next five years, while Qwest signed a three-year contract in September 2000 to purchase $300 million in equipment. Cable & Wireless (NYSE: CWP), Tellium's only other customer, also inked a $350 million, five-year purchase agreement in September, but those sales have yet to start coming in the door.
While the $900 million of the three contracts is surely a lot of money over the next five years, current income hasn't stemmed the company's short-term bleeding. In the first quarter ended March 31, 2001, Tellium had an operating loss of $52.5 million after a pro-forma 2000 operating loss of $151.3 million.
Tellium's inability to attract other big-name customers -- there's no mention of any company other than Cable & Wireless conducting tests with Tellium switches -- gives other companies such as Sycamore Networks (Nasdaq: SCMR), Nortel Networks (NYSE: NT), and Tellabs (Nasdaq: TLAB) time to refine their optical offerings. Privately held Calient Networks, which also is focusing exclusively on the long-haul optical switch market, may already have usurped some of the momentum that Tellium enjoyed in its September round of financing. In January, the San Jose, California-based company raised $225 million.
At first glance, the IPO is as expensive as they come. With just $27.8 million in trailing 12-month sales, Tellium would originally price at 53.9 times those sales. That compares to just 7.8 and 16.4 times sales for Sycamore and Ciena (Nasdaq: CIEN), two other optical switch manufacturers.
But Wall Street always prefers the promise of the future to the reality of the past. On that basis, Tellium would price at roughly 6.8 times the sales that its existing contracts imply for this year, compared to 7.8 and 9.1 for Sycamore and Ciena, respectively. And it could get better: the company may be forced to reduce the asking price further to compensate new investors for their patience.
That said, despite the fact that Tellium may have the products that will be used in next-generation networks, Mr. Carr & Co. will likely still have a difficult time convincing public investors that the company will be a long-term survivor. Its trip into the public markets will only be the beginning, akin to the return journey of a salmon to its breeding grounds. On average, out of every 1,000 eggs laid, one survives to return and spawn. Tellium's chances are much higher than that, but we'll wait until they're a little farther upstream. |
