** WashPost. The Deal That Got Disconnected. Ciena's Merger With Tellabs Seemed Set Until the Phone Rang. The Question Is: Why Then?
washingtonpost.com
By Mike Mills
Washington Post Staff Writer
Monday, September 7, 1998; Page F12
At 9:20 a.m. on Aug. 21, Michael Birck thought he was 40 minutes away
from a fairly routine shareholders meeting. The 60-year-old chief executive
of Tellabs Inc. sat at his desk, proofreading his remarks. He had even
prepared a slide show, which he would use to explain the logic behind the
$7 billion acquisition of another telecommunications equipment company,
Ciena Corp., that shareholders were about to approve.
Then the phone rang. It was Patrick Nettles, president and chief executive
of Linthicum-based Ciena, with bad news: AT&T Corp. had just called to
say it would no longer be interested in testing Ciena's flagship product, a
device that increases the transmission capacity of fiber-optic cables by
40-fold.
"We were sitting there, fat, dumb and happy, thinking this deal was going
to materialize," Birck recalled in a telephone interview from his Lisle, Ill.,
headquarters. "Then he calls and drops this on me."
Birck immediately phoned his lawyers, but he knew what they would say.
He had to cancel the meeting. Without AT&T as a customer, Ciena would
lose as much as $100 million of potential revenue for the coming year. Wall
Street surely would downgrade Ciena's earnings estimate, and its stock
value. "You can't hold a shareholders vote when you're in possession of
this knowledge and the shareholders are not," Birck said.
After further negotiations, Ciena agreed to a new price of around $4
billion. But the deal remains shaky: Ciena's stock has lost 56 percent of its
value since Aug. 21 and is almost back down to the price at which it went
public in February 1997, $23. Two class-action shareholder lawsuits have
been filed alleging that Ciena withheld vital earnings information. The
Securities and Exchange Commission has vowed a thorough, 30-day
review of the new terms. And there's plenty of time for more trouble,
because shareholders won't meet to finalize the deal until midNovember.
"Sitting duck," moaned one Ciena official.
The lingering question is why AT&T chose that moment -- an hour before
final approval of the merger -- to end its relationship with Ciena. AT&T
declined comment, though Nettles said AT&T Vice President Dan
Sheinbein, who made the call, claimed not to know that the merger was set
to be approved by Ciena and Tellabs on the same day AT&T cut its ties
with Ciena.
The most sinister theory is that AT&T was doing a favor for one of its
offspring, Lucent Technologies Inc., Ciena's arch nemesis in the
fiber-capacity-enhancement business.
"We did nothing, were in no way involved, and did not even talk to
AT&T" about Ciena, said Kathy Szelag, vice president of marketing for
Lucent's optical networking group. "Clearly I've heard the rumors. We are
just baffled."
So are Birck and Nettles.
"It is just bizarre. There is to my knowledge no justification for what
happened," Birck said. "It's unprecedented in my experience that a
company would call another and say we aren't going to even evaluate your
product, to single out one of several contestants for that honor."
One thing is certain: Ciena is no longer the unblemished Cinderella story of
telecom. The disastrous events surrounding the merger with Tellabs is
merely the low point in what has been a dismal year for the company,
whose factory and headquarters are minutes from the
Baltimore-Washington Parkway.
Big Chill for a Hot Company
A year ago Ciena was celebrated as one of the hottest new telecom
equipment companies.
Nettles and three other entrepreneurs formed Ciena on the belief that the
Internet would create an insatiable demand for data, leaving
telecommunications carriers gasping for wider pipes to handle the
information glut.
Ciena's "dense wave-division multiplexing" (DWDM) boxes greatly
expand the carrying capacity of a fiber network. They work by splitting the
light that travels through fiber-optic cables into prism-like colors, with each
color acting as a channel through which information flows in pulses of light.
Ciena sold its first devices to Sprint Corp. WorldCom Inc. soon followed,
along with Bell Atlantic, Cable & Wireless and smaller carriers around the
world. Revenue shot from $50 million in 1996 to $350 million in 1997, and
in February of that year Ciena raised $3.4 billion in what was the largest
initial public stock offering ever.
Ciena could hardly expand fast enough to keep up with the orders, hiring
1,500 people and building a highly sophisticated manufacturing facility.
But while Ciena might have been first to recognize the potential market for
wave-division products, its rivals were catching on quickly. Soon Lucent
and other large telecom equipment giants began challenging Ciena's
expertise in shipping large volumes of DWDM devices.
About 13 other vendors -- including Nortel, Seimens, NEC and Pirelli --
now offer competing DWDM products. The DWDM market is worth
about $1.5 billion this year, and growing at 50 percent annually, analysts
estimate. Ciena has a third of that market; Lucent slightly less than a third.
Most of Ciena's larger rivals have a starting-gate advantage: In addition to
their larger resources for research, marketing and production, most have
been doing business with potential customers -- phone companies -- for
years and have formed long-standing relationships.
"Almost any telecommunications carrier, especially the bigger carriers and
the regional Bells, have been working with these other suppliers, like
Nortel and Lucent, for quite some time," said Tim Savageaux of Volpe
Brown Whelan in San Francisco. "And if they feel they can get a product
from them that's equal or better, even if they have to wait three to six
months longer, they'll go with them and reduce the risk of going with a
newer and unproven vendor."
That Ciena had a technological edge was almost secondary: Last year
Ciena unveiled a device that expands capacity 16-fold instead of eight, and
the company said a 40-channel model would come along soon. Not to be
outdone, Lucent in January announced that AT&T would begin installing
an 80-channel model by the end of this year.
Ciena executives were outraged at Lucent's promise: Not only did Lucent
not have an 80-channel product ready for the market, but it wasn't even
working on a 40-channel product. Nonetheless, its announcement gave
customers the impression that Lucent had leapfrogged Ciena.
"The perception was that Lucent had a very wide technological lead.
Someone like Lucent can influence customer buying behavior even without
having a product, just because of its incumbent relations and size,"
Savageaux said.
Added Birck: "That's called freezing the market. Making prospective
customers not do anything in anticipation of something better down the
road."
Ciena's next bit of bad news came in February: WorldCom, Ciena's
second-largest customer, said that it would slow down its purchasing of
Ciena equipment, a decision that would shear about $50 million in
second-quarter revenue from the company. Ciena shares dropped almost
30 percent on the news.
In an interview, WorldCom Vice Chairman John Sidgmore said his
company had simply found a more efficient way to use wave-division
boxes and didn't need as many as quickly as it had projected. He added
that, once WorldCom's merger with MCI Communications Corp. is
finalized, more such equipment will be needed to mesh the WorldCom and
MCI networks. But, unlike two years ago, Ciena now will have to fight
harder for WorldCom's business.
"We're in the middle of an evaluation process," Sidgmore said. "Ciena is a
really good company that is now facing competition for the first time.
They're going to have to continue to innovate, and come up with the
next-generation product."
High Expectations
Against that backdrop of uncertainty, Ciena officials were hopeful: They
were trying to rope their biggest prize ever: AT&T.
With 41,000 miles of fiber optics coursing through the United States,
AT&T's network was a ripe target for Ciena's products. Ciena also was
encouraged by AT&T's new "multi-vendor" policy, which AT&T
spokesman Dave Johnson defines as having "a minimum of two primary
vendors" for any equipment purchase, whenever possible.
In 1997 AT&T signed an agreement with Ciena that it would begin testing
its 16-channel MultiWave DWDM system on its data networks. With that
announcement, Ciena was invading Lucent territory: About 80 percent of
Lucent's DWDM sales are to its former parent.
"We've been pleased by Ciena's products and are very encouraged by the
capacity and reliability the MultiWave system can offer us," said George
Gawrys, manager of transport planning for AT&T, in a Ciena press release
dated June 3, 1997.
Ciena said the trial would be undertaken "with a view toward possible
implementation beginning in 1998," a statement that led Wall Street
analysts to begin expecting $50 million to $100 million in 1998 Ciena
revenue from AT&T.
In August 1997 Ciena heightened expectations further by announcing a
new "five-year contract" under which Ciena would supply its MultiWave
systems to AT&T, "after successful evaluation." The company warned in
the same statement, however, that it was making no assurances that AT&T
would make any purchases.
By all accounts, AT&T's year-long evaluation of Ciena's equipment went
horribly. Ciena was plagued by numerous failures in its electronic
components -- something that Nettles said had never before happened to
the company.
One thing that spooked Ciena engineers was that AT&T was testing their
gear, as one put it, in "enemy territory." Though Lucent had been spun off
from AT&T two years ago, AT&T still shares a huge laboratory facility
with Lucent in Holmdel, N.J.
AT&T and Lucent said they have strict rules separating their research
activities. And while Ciena officials describe themselves as "concerned"
that Lucent may have interfered with Ciena's evaluation, they declined to
elaborate.
"There were a lot of failures that were uncharacteristic of our past
experiences," said one Ciena engineer who worked on the AT&T
evaluation, which began in November 1997. "However, most of these are
things we were really manufacturing for the very first time."
Meanwhile, Tellabs began talking with Ciena about a merger in February.
Tellabs is a 24-year-old company that has built a solid business out of
making equipment that helps phone companies manage their networks.
The merger announcement in June was greeted enthusiastically by Wall
Street. But behind the celebration of the planned marriage, Ciena officials
were busy putting out a fire. Literally.
Around midnight, two days before the merger was announced, an AT&T
employee noticed smoke coming out of a Ciena power supply circuit
board. Smoke or fire in a lab test is probably the worst thing that can
happen to an AT&T vendor: AT&T officials still shiver when they recall
Mother's Day 1988, when a fire swept through a phone switching facility in
Hinsdale, Ill., knocking out service for weeks. Within days AT&T asked
Ciena to remove its equipment.
Ciena sent the board to a third-party testing facility, which cited faulty
circuit construction as a probable but inconclusive cause. The incident did
little to persuade AT&T that Ciena was capable of supporting its
equipment at the scale AT&T needed.
"Probably Ciena didn't respond as aggressively as they might have, or as
we would have," Birck said. "You just have to take that kind of thing
extremely seriously. You have to define the root cause. I don't think they
did that."
In a merger document filed July 21, Ciena and Tellabs disclosed that
AT&T had concluded it would be "inadvisable" to deploy Ciena's
16-channel system. Without naming any vendor, AT&T said its capacity
requirements had grown so much that it would explore other "commercially
viable" higher-channel systems.
It wasn't until July 30 that Wall Street got wind of the disclosure, and sent
Ciena and Tellabs shares tumbling. Ciena officials tried to calm Wall Street
by saying they believed AT&T would still choose Ciena.
As the merger drew toward final approval, investors began to add up the
damage: The WorldCom purchase delay, AT&T's balking at buying Ciena
equipment, intense pricing pressure from Lucent. And while Ciena had
found some new customers, its goal of attracting business from the regional
Bell companies or smaller carriers was slow-moving. Bell Atlantic was the
only Bell to buy Ciena boxes, and at an underwhelming $15 million over
several years.
Some analysts had long thought that Ciena had over-promised and was
overvalued. But soon even analysts who had been keen on Ciena began to
ask: How could its revenue and profit targets continue unchanged through
all that turmoil?
The reality was that Ciena was nowhere near meeting its profit
expectations. Because the merger was set to close on Aug. 21, the
company was under no obligation to issue third-quarter earnings as a
separate entity. But at Birck's urging, Nettles decided to make the revised
estimates public.
On Aug. 14 Ciena warned investors that its third-quarter profits would be
less than half what analysts were expecting, 13 to 15 cents a share rather
than 32 cents.
Shares of Ciena fell that day and more analysts began speculating that
Tellabs was paying too much for Ciena. But Nettles and Birck still believed
shareholders would easily approve the merger the following week.
But on Aug. 21, AT&T dropped its bombshell, and the merger's approval
was postponed. Within days a new deal was negotiated: Instead of a
one-for-one stock swap for Tellab and Ciena shares, Ciena shareholders
now would get four-fifths of a share for each Tellab share. In essence the
$7.1 billion deal had become a $4 billion deal -- in less than three months.
A Question of Timing
There are a lot of plausible explanations for why AT&T would want to
drop Ciena as a potential vendor. The trial with AT&T clearly didn't go
well. And there were other possible factors too. Maybe the personal
relationships between the two companies soured. Or maybe AT&T simply
felt that the products and support offered by other vendors were superior
to what Ciena offered.
But why did AT&T choose that moment, on the verge of the merger's
closure, to inform Ciena of its decision?
Did AT&T want to do Lucent a favor by throwing a wrench into Ciena's
merger? Nettles and Birck won't go that far. But some investor analysts
suggest that may be the case.
"Lucent feels threatened and they go to their old buddy AT&T and they
either cut a deal or they make some promises," speculated one Wall Street
analyst, who requested anonymity. "If you're an AT&T executive you're
probably a Lucent shareholder."
Others reject that notion.
"That's so preposterous," said Nikos Theodosopolous of Warburg Dillon
Reed. "What does AT&T have to gain in listening to what any vendor
wants? That AT&T, which has a brand new CEO and an independent
board, is going to sit back and let Lucent tell them what to do doesn't
make logical sense."
AT&T isn't offering much guidance. "We're just not in a position to
comment on what Ciena announced," said spokesman Johnson. "We are
buying lots of equipment from lots of different vendors. What we're looking
for is the best equipment that we feel will match best with the network."
Birck and Nettles now say they don't need AT&T's business to succeed.
After all, it's a huge, global market. And as demand for data capacity
grows, so will the market of telecommunications carriers eager to buy
Ciena products.
So, too, will the capabilities of Lucent, Nortel, Alcatel, Seimens, Pirelli and
other companies that prowl the market for wave-division products. That's
where Tellabs will help Ciena, Birck said. He points out that the company
has prospered in other equipment areas, against those giants, and never
had AT&T as a big customer.
"We understand this business well enough," he said. "We can compete with
those guys head-on. We win our share."
CIENA IN TURMOIL
(This graphic was not available)
MILESTONES IN THE HISTORY OF CIENA CORP.
November 1992: Incorporates in Delaware.
February 1994: Sevin Rosen Funds invests $3 million.
February 1994: Patrick Nettles is appointed chief executive officer.
December 1995: Headquarters and manufacturing is established in Savage,
Md.
January 1996: Receives final $26 million of $40 million venture capital
funding.
March 1996: Introduces MultiWave 1600, which improves efficiency of
fiber-optic lines by 1,600 percent.
June 1996: Installs MultiWave 1600 in Sprint Corp.'s network. Announces
upcoming product to improve fiber-optic efficiency by 4,000 percent.
January 1997: Announces exclusive contract with WorldCom Inc.
February 1997: Public offering on Nasdaq sets record for start-up at $3.4
billion.
April 1997: Headquarters moves to Linthicum.
May 1997: Announces contract with Digital Teleport. Sets record for first
year of sales with $195 million.
May 1997: David Huber, who invented the technology, resigns.
June 1997: Signs first European customer, Cable and Wireless
Communications.
August 1997: Reaches agreement with AT&T to provide MultiWave
systems for five years.
December 1997: Reports profit for the year was up 767 percent to $113
million from the year before.
January: Ciena acquires ATI Telecom International, Ltd. in a stock deal
valued at $52.5 million. Rival Lucent Technologies Corp. announces it will
offer a product that sets a new industry standard by expanding one
fiber-optic network channel to 80 channels, sending Ciena's stock down.
February: WorldCom reduces orders from Ciena, saying it will use the
company's telecommunications equipment on an as-needed basis. The
news sends Ciena's stock tumbling, a day after Ciena reported a doubling
of profits in the first quarter.
March: Ciena signs three-year contract anticipated to be worth $100
million in the first year to provide Sprint with fiber-optic equipment.
April: Wins $13 million contract from Digital Teleport Inc. Acquires Santa
Barbara, Calif.-based Terabit Technology Inc. in a deal worth $11.7
million. Ciena signs exclusive one-year contract with Hermes Europe
Railtel BV of Belgium for the company's first major installation of its
40-channel product outside the United States.
May: Ciena reports net income of $15.3 million for the second quarter.
June: Ciena agrees to pay Italy-based Pirelli $30 million to settle patent
infringement cases.
June 3: Tellabs Inc. announces it will buy Ciena for about $7.1 billion in
stock.
Aug. 14: Ciena's stock drops almost 24 percent after the company
announces third-quarter earnings will be sharply lower. Shares of Tellabs
fall 19 percent.
Aug. 21: Ciena and Tellabs delay vote on the merger when AT&T
announces it will not consider buying Ciena's multiplexing system. Ciena
stock drops 45 percent. Tellabs' rises 9 percent.
Aug. 28: Ciena and Tellabs renegotiate the deal, revaluing it to about $4
billion. Ciena's stock rises but Tellabs falls on the news.
Sept. 2: Ciena stock tumbles another 15 percent to 28.46M on news that
Ciena and Tellabs will delay a shareholder meeting scheduled for
Wednesday until sometime in November.
HIGHFLYING START
(This graphic was not available)
c Copyright 1998 The Washington Post Company
|
