In New World of Telecom Gear, It’s Eat or Be Eaten

The giant telecom gear suppliers have finally gotten the message: The future is in data.

Increasingly, they are digging into their deep pockets to buy the technology and customer access they’ll need in the fast-approaching era of “successor” networks--souped-up pipes that carry voice, data and video.

The game began in earnest last year with Northern Telecom’s $7.6-billion acquisition of Bay Networks. In January, the $20-billion combination of Lucent Technologies and Ascend Communications quickened the industry’s upheaval.

Since then, France’s Alcatel announced a $2-billion pact with Xylan, and last week German behemoth Siemens said it shelled out $570 million for two private companies and a stake in a third, creating a U.S. unit focused on data transport.

As the coterie of publicly traded target companies shrinks, the stakes for investors are rising. Most of the remaining candidates, such as Fore Systems, Advanced Fibre Communications and Cabletron Systems, are trading far below their all-time highs, having been battered by rivals--particularly Cisco Systems and Lucent--and their own strategic miscues. And those left standing when the music stops may find it all the more difficult to compete.

On the other hand, analysts say these companies offer valuable know-how and could give potential suitors a foothold in the U.S. telecommunications equipment market, where 40% of global revenue is generated.

Yet takeover murmurs have hardly helped the stocks. Indeed, fears of being left out weigh on both potential acquirers and targets, analysts say.

Look at Xylan. Shares of the local-area-network innovator had stagnated around $20 before the $37-a-share Alcatel deal, despite the company’s 60%-plus earnings and revenue growth in 1998. And Alcatel stock climbed when the merger was announced.

“That’s the signal that Wall Street is giving them,” said analyst Michael Davies of Punk, Ziegel & Co. “Data services are growing exponentially, and Wall Street wants these telecom companies to make their moves.”

Takeover talk has surrounded Ciena Corp. throughout its short life as a public company. Ciena pioneered a vital technology--dense wavelength division multiplexing, or DWDM--that vastly increases the capacity of fiber-optic strands by splitting light into numerous channels.

Tellabs agreed to a $7.1-billion merger with Ciena last year, then canceled the deal after Ciena lost an AT&T; contract to Lucent and other business fell through. In the process, Ciena’s sales eroded, margins capsized, and the stock sank to $8 from a high of $92.

The Tellabs rumors have resurfaced as Ciena mounts a turnaround. It is the only vendor to sell a 96-channel DWDM product, Davies says, but mighty Lucent commands greater market share. A red flag for investors: Although the international arena is expected to blossom, Sprint now contributes more than 40% of Ciena’s revenue, and two other clients account for 30%.

Thanks in part to Ciena, data zips through the long-haul network, but there’s a bottleneck between the telephone company’s switches and the consumer. ADC Telecommunications, a diversified vendor with a strong stock, and Advanced Fibre Communications, a one-trick pony trading in the single digits, both address this problem.

ADC, which sells an arcane array of connection devices, has the heft to give an aspiring global gear vendor a firm U.S. foothold. Its varied offerings are in demand by long-distance and local telephone companies in addition to cable TV companies. “It has a suite of strategically important products as well as the cable business,” said analyst Steven Levy of Lehman Bros. “Cable is in a dramatic upgrade cycle as the providers prepare to deliver two-way voice, video and data.”

Levy mentions NEC and Fujitsu of Japan as possible acquirers that need to play catch-up, while Davies believes ADC would be a good fit with Cisco, which has put priority on voice-data convergence. “Cisco needs a company like ADC to build its business with service providers,” he said.

Advanced Fibre’s electronics work in the “local loop,” funneling data and voice traffic between telecom networks and customers in rural or developing areas. Big suppliers like DSC, now a unit of Alcatel, sell similar products for urban zones. General Electric of Britain recently conscripted another rival, Reltec.

AFC shares collapsed after the firm lost its biggest client, GTE, and it still hasn’t sold the regional telephone companies on its offerings. But analysts call AFC’s box the most flexible and effective integrator of voice and data in its niche. “Short-term there are definite challenges; longer-term there’s tremendous opportunity,” said Hambrecht & Quist’s Reginal King, who pegs the company’s takeover value at $18 a share.

Asynchronous transfer mode, or ATM, is a futuristic technology whose time has come. Telephone carriers are beginning to install powerful ATM switches to speedily deliver voice and data with the quality of service telephone customers expect. That wasn’t lost on Lucent when it bought out ATM leader Ascend.

Any company that wants to enter this field has to be sizing up Fore Systems. The Warren, Pa., company sells ATM switches for local-area networks, a niche that hasn’t lived up to grandiose growth forecasts.

Despite its limited success in the lucrative telecom market, Fore is in an excellent position to be courted, Davies says, citing Fore’s strong technology, bargain market cap of 2.6 times sales (the more diversified Ascend fetched 13) and opportunities in the telecom market with an Ericsson or Alcatel behind it.

By the price-to-sales measure, Cabletron would be even more of a bargain. But Cisco’s assault on its bread-and-butter LAN franchise has wrung all optimism out of the stock.

Cabletron does have respected technology in the form of high-speed switches and network management software. Nutmeg Securities analyst Andy Shopick, however, expects a suitor to be most interested in Cabletron’s broad customer base, built up since its days as an industry prince. Even with those assets, Shopick considers the prospects for a turnaround at Cabletron “uncertain.”

One thing that is certain is that boundaries even beyond those that separate voice and data firms are falling. Today, Intel, Microsoft and Hewlett-Packard, in alliance with Nortel, are expected to announce plans to stake their claim to telecommunications.

“I have seen so much happen in this space with the convergence of technologies,” said Shopick. “Anything is possible. That’s the beauty of it.”

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Times staff writer Edward Silver can be reached via e-mail at edward.silver@latimes.com.