Must-read. Mergers seen as natural in a maturing fiber industry
broadband-guide.com
Features, August 1998
By Robert V. Pease, Associate Editor
With the constant introduction of new fiber-optic technologies and
applications, companies frequently find themselves scrambling for
a piece of a new market segment. Thus, mergers and acquisitions
have been a regular part of the fiber-optics industry for years.
However, several recent mergers and acquisitions may warrant a
closer look. First was the more than $7-billion combination of
Tellabs (Lisle, IL) and CIENA Corp. (Linthicum, MD). Tellabs, a
major player in the voice and data transport and access systems
market, will now incorporate CIENA's expertise in dense
wavelength-division multiplexing (DWDM) and switching
technologies. The combination is expected to catapult Tellabs as a
major provider in the advanced, high-speed network arena.
According to CIENA's president and chief executive, Patrick
Nettles, the merger is "about joining forces in order to do things
that simply weren't possible for either of us" and provide an
"opportunity to play a much bigger role" in the marketplace in the
next several years.
On the heels of the Tellabs/CIENA announcement, Alcatel
(Richardson, TX) unveiled an agreement to purchase DSC
Communications Corp. (Plano, TX) in a deal worth more than $4
billion. A European-based telecommunications-equipment
manufacturer with operations in more than 100 countries, Alcatel
will strengthen its U.S. presence significantly with its acquisition of
DSC, which is a provider of switching, transmission, access, and
network-management systems.
Finally, Nortel (Brampton, ON, Canada), a major digital
networking solutions provider, put the rumors to rest with a
$9.1-billion purchase of the data-networking firm Bay Networks
(Santa Clara, CA). The merger enables Nortel to expand its
Internet protocol network expertise and leverage Bay Networks'
established distribution channels.
These consolidations appear to have several factors in common.
First, these transactions represent billion-dollar deals, so sheer size
is an important issue to consider. Also, manufacturers appear to
be making a concerted effort to expand their product offerings.
The Nortel deal illustrates how a traditional
telecommunications-equipment vendor could use the acquisition of
a data-communications hardware provider to gain expertise in a
whole new area. Are the actions of these six companies
representative of things to come? Are the advantages of size,
efficiency, broader focus, competitiveness, and interoperability
leading to a rash of mergers and acquisitions within the fiber-optics
community? These and other questions are on the minds of
customers, investors, employees, and anyone with ties to the
industry - and analysts are working overtime to provide some
answers.
Good time to merge
According to Fred McClimans, chief executive and director of
analytical operations for Current Analysis Inc. (Sterling, VA), the
recent merger trend has everything to do with industry maturity.
He says the growth of the industry over the past few years,
coupled with increased user demand, increased technological
development, and a requirement for venders to have access to
new markets and technology, has created a very favorable
environment for successful mergers to take place.
"For existing companies to continue to grow and survive," says
McClimans, "they must acquire new technologies, new companies,
and new markets. This growth is no longer affordable or
achievable internally." [Do you think LU is listening?]
Robert Rosenberg, president of Insight Research Corp.
(Parsippany, NJ), says that the trend toward market consolidation
appears throughout the entire economy.
"The mergers in the fiber market are not taking place in a black
box," says Rosenberg. "The recent high evaluations of stock price,
regardless of what industry you're looking at, make it a favorable
time to engage in these types of activities." However, the
telecommunications industry has a few unique aspects, he says.
First are the economies of scale. It takes billions of dollars of
investment to provide a service that you're charging pennies a
minute for, so the only way to pay off that investment is to "keep
the pipe filled." In the telecommunications-services market,
Rosenberg believes we're moving forward from a 100-year history
of circuit switching into a new frontier where cell-based switching
is becoming ubiquitous across networks. Companies must make
moves to keep abreast of technology if they want to continue to
survive in a fiercely competitive environment. That means service
providers must integrate new technologies into their networks -
and the manufacturers that serve them have to have products
ready to meet this need.
Several drivers
Analysts attempting to put their finger on the driving force behind
mergers and consolidations point to three areas: market growth
and position, new technology, and customer demands. Most agree
that all three factors contribute to a favorable merger environment,
yet there is some division among market-research companies
regarding the primary driver.
McClimans believes the predominant driver is a company's
requirement to maintain high market growth. "I believe one of the
primary concerns of a company is to increase its stock values,"
says McClimans. A high level of company growth, he says, can
have a profound effect on the stock market.
To maintain a high market value, he believes, companies will seek
acquisitions for three reasons. First, they want to gain new
technologies and expertise to expand their market capabilities and
shore up their existing product technologies. Second, many
companies simply want to add mass to their infrastructure by
bringing on a diversity of products, a significant increase in staff,
and a rapid increase in revenue. They hope to join that "billion-,
5-billion-, or 10-billion-dollar club," in McClimans's words. Third,
acquisitions take place to gain access to new markets. To
penetrate a foreign market, for example, you need to "buy
somebody with a lot of feet on the street," McClimans explains.
Regardless of the motivation behind a merger, it will still boil down
to the necessity of maintaining an overall high level of company
growth, says McClimans.
On the other hand, Pioneer Consulting (Cambridge, MA) senior
analyst, Scott Clavenna, points to technology as the main driver of
recent mergers. The migration from time-division multiplexing
(TDM) to today's explosive DWDM technology is the principal
technological trigger, he says. By merging, says Clavenna,
companies can bring the latest technologies into their own
organizations and expand their product lines.
However, he agrees with McClimans that a primary reason for
merging is to gain access to a customer base. "By gaining access
to an acquisition's installed customer base and capital reserves,
products can be introduced more quickly into the market," says
Clavenna. "The DWDM and fiber access markets are growing so
quickly that time-to-market can make a tremendous difference
between success and failure." [Time-to-market has always been ASND's strength.]
Finally, customer demands and the telecommunications provider's
absolute need to meet them are, in some opinions, driving more
mergers. With competition raging throughout the industry,
satisfying customer needs is critical if a provider wants to remain
positioned among its peers. According to Bill Kleinebecker, senior
consultant for Technology Futures Inc. (Austin, TX), a
telecommunications technology management company, the real
drivers are the standout telecommunications service providers.
These providers have a requirement to meet customer demand for
more services from a single source.
"They, in turn, select their equipment manufacturer based not only
on where they will get the best deal in terms of quality and price to
make bundled services possible," says Kleinebecker, "but also
where they can get the advanced technology that fits and will
bridge to their view of the future network. Service providers, to
more safely navigate toward that technology vision, will pick a
single equipment partner to supply that future vision."
That doesn't mean telecommunications providers must actually
acquire equipment manufacturers, says Kleinebecker, because
there is a distinct boundary there. It does mean, however, they
must take a certain amount of risk in deciding which technology
combinations, such as Asynchronous Transfer Mode (ATM), new
fiber products, and DWDM, to pick for their service offerings and
then determine which equipment vendor they will work with to
supply that technology.
"The equipment provider that offers the largest portfolio of those
technologies most in demand, whether gained through acquisitions,
mergers, or agreements, will be the one who remains competitive,"
says Kleinebecker. "So as more new technologies become
necessary, companies will seek to acquire them, and mergers are
one way they're doing it."
Outlook for upstarts
How do small companies break into an industry that is increasingly
being dominated by fewer and fewer - but larger and larger -
companies? "By being faster, better, and cheaper," says Insight's
Rosenberg. "There will always be a role for the better and
probably the faster, although cheaper is becoming less and less
significant because of downward pressures on cost."
Companies developing specialized technology or manufacturing
processes that either add value to a component or system or
reduce its cost will find a niche, agrees Pioneer's Clavenna.
However, he believes cost will continue to be a major determinant
as the DWDM market moves into local exchanges. Low-cost
components, subsystems, and manufacturing processes will be
highly sought after in this market over the next decade, he says.
Generally, the future of the fiber optics industry is not conducive to
new ventures, according to most researchers. The stakes are high,
the risks are great, and the support requirements are substantial -
as are the odds against smaller players keeping pace. "Most small
players are hoping and wishing and praying every night that
somebody comes along and justifies the money they've borrowed
from venture funds," says McClimans of Current Analysis. "Money
is flowing into emerging companies for one of two reasons - either
to create a company that can dominate the marketplace and be a
significant challenger to the top tier or to build a company that can
be acquired for a relatively quick rate of return. In this
marketplace, slow growth is almost as bad as no growth."
But McClimans concedes there is some hybrid space in the
middle. Some venture funds are looking to invest in firms they
believe can carve out a niche and maintain that niche. Usually,
though, it's a fallback position, he says. If the company fails in
several areas, it can at least fall back into a niche it can defend.
More of the same
It is almost a certainty, say the analysts, that more mergers and
acquisitions are in the future for the fiber-optics industry. The
technology is ever-changing, the stock market is favorable, and
customers are demanding more from suppliers and providers.
"The prognosis for the near-term future is more of the same at an
increasing pace," says McClimans. "Every company out there has
its own business plan and strategy. Every time an acquisition
occurs, it forces them to rewrite that strategy." [Can you say NT/BAY?]
From a day-to-day operations perspective, companies are unable
to take every contingency into account, so being prepared for
industry shake-ups is far from an exact science. Some companies,
McClimans says, will discover, almost overnight, that they are no
longer number one, or even number two, in terms of market
presence, size, valuation, and growth. This realization may force
them to speed the pace of mergers and acquisitions to regain their
position in the marketplace. So, hold onto your hats, say the
analysts. The future of fiber will likely be full of surprises.
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