Once a Bit Player, Tekelec Now Star on Telecom Stage
If there was once a corner of the business world furthest from the telecommunications revolution, it could easily have been the niche that Calabasas-based Tekelec Inc. carved out for itself years ago.
The company, founded in 1979, built its name designing equipment used to simulate an obscure piece of the telephone network known as Signaling System 7.
“It was very low on the sexy scale,” said Tim Savageaux, senior analyst with W.R. Hambrecht & Co. in San Francisco.
But a funny thing happened on the way to the technological revolution.
Although largely ignored by the major players over the years, SS7 has become a key piece in the race to create the next-generation telephone network--one drawn from merging the speed and efficiency of Internet-like computer networks and the sturdy dependability of traditional telephone networks.
The so-called convergence of data and telephone networks marks one of the most significant transformations of telecommunications, and Tekelec, through a little luck and skill, has ridden the Signaling System 7 wave into the middle of the storm.
“You know the old saying: The harder I work, the luckier I get,” Tekelec Chief Executive Michael L. Margolis said.
SS7 was originally designed as a kind of electronic traffic officer that used modern computer-like communications to control old-style telephone network switches. Its ability to comfortably communicate with both worlds has made it one of the potential gateways for convergence.
The old Tekelec that made simulation equipment is quickly fading away. In its place is a new company that has refocused itself on making the devices that will enable the next generation of fast, efficient and feature-loaded phone service.
“SS7 is a critical mediation technology between what is there now and what is coming,” Savageaux said. “Tekelec has done a great job from both a strategic and a tactical standpoint. No question, they’ve figured it out.”
Tekelec, with 925 employees now, has already begun to reap the bounty of the convergence movement.
From its initial stock offering in 1986 to as recently as three years ago, the company’s stock barely budged from $5 a share or less. But since then, its stock has surged, climbing from a low of $6.69 a year ago to a Friday close of $48.19, up $2, on Nasdaq.
The company counts among its customers and partners many of the largest firms in the business, including Global Crossing Ltd., Bell Atlantic Corp., AT&T; Wireless, Lucent Technologies Inc., Cisco Systems Inc., Tellabs Inc. and US West Inc.
Tekelec’s revenue has been growing at an average of 35% a year, increasing from $125 million in 1997 to $226 million last year. Analysts have predicted that the company will continue to grow at the same rate this year, boosting its revenue to more than $300 million.
The company has been profitable through most of its history, although last year its net income was just $440,000, largely because of an increase in research spending and $29 million in costs connected with its purchase of another company for $163 million. During the first quarter of this year, the company lost $1.8 million.
The question facing Tekelec is whether it can capitalize on the convergence movement before convergence is all wrapped up.
Companies such as computer networking giant Cisco Systems evangelize that the whole telephone system will one day run over a network based on the same standards as the Internet, essentially making the old telephone network a pile of junk.
That might take decades to happen. But long before that, there will be dozens of hungry competitors with new ideas.
The traditional telecommunications behemoths, such as Nortel Networks Corp. and Alcatel, have their own products that use the SS7 network.
Younger companies such as IpVerse Inc. of Sunnyvale, Calif.; Richardson, Texas-based IPCell Technologies Inc.; and Sonus Networks Inc. of Westford, Mass., have emerged in the market as well, selling other equipment that strikes at part of the SS7 puzzle.
But Margolis said Tekelec’s dominance in the SS7 market and its expertise in the system’s complex workings have put it in a commanding position that could help launch the company out of its narrow niche into the broader world of networking.
The key to understanding Tekelec’s products requires a trip back into telephone history.
In the early days of the telephone system, phone calls were set up by human operators who connected two parties by physically plugging in switchboard wires to complete a circuit.
The method was slow and eventually was replaced by an automatic system in which calls were set up using a series of either electrical pulses from rotary dials or, later, the familiar electronic tones of modern telephones.
But the tone system still took too long and was vulnerable to telephone hackers, who learned how to imitate the tones to make free long-distance phone calls.
The solution came in the mid-1980s with the introduction of Signaling System 7, which created a separate network to connect the telephone company’s switching equipment.
In essence, the talking part of a phone call now travels over one set of wires, while all the necessary commands to control a call, such as telling equipment when to connect and disconnect, are carried over another.
Two decades ago, Tekelec began life as the distributor of French electronic equipment used by engineers to simulate an early computer network.
It was a tiny company and stayed that way for nearly a decade until it bought a North Carolina company that created similar equipment for designers of SS7 equipment.
The acquisition came just when SS7 was becoming a standard part of the telephone system, and the company prospered, selling mainly to companies such as Lucent, Nortel and Alcatel.
The company would have stayed small and obscure except for an idea that came from one of its customers in the early 1990s: that Tekelec’s SS7 simulators could be adapted to replace some of the real pieces of the SS7 network--at a substantially lower cost than what was then on the market.
Tekelec decided to give the idea a try and focused on the central component on the network, a device responsible for routing SS7 information to its proper destination, called a “signal transfer point.”
Most analysts thought the transfer point market was too small to bother with.
As it turned out, they were stupendously wrong. The transfer points became an easy way to provide new services, such as caller ID, 900 numbers and cellular phone roaming, that required the use of a computer and vast databases of information.
Even though established companies such as Alcatel and Nortel made similar devices, Tekelec seized nearly 80% of the North American market, largely because its equipment was cheaper and faster.
The digital heritage of the transfer points is what now makes them a key in the creation of the next-generation telephone system. The devices not only serve as a bridge between computers and the traditional phone system, but they also help connect the telephone network to the Internet.
That connection opens a range of new services, such as using the Internet for call waiting and routing calls to other phones, that phone companies lust after because of the promise of new revenue.
Last year, Tekelec acquired Richardson-based IEX Corp., which among other products makes the computer, database and software applications for the phone system’s enhanced services. “We are the enablers of reliable convergence,” Margolis said. “Tekelec supplies everything now but the switches.”
In many ways, the broadening of the company’s scope poses its biggest challenge.
Instead of being a dominant player in a niche market, it now competes with the biggest names in the business.
Nortel, for example, offers customers a full range of products from one end of the telephone network to the other. Instead of customers piecing together a network, Nortel can provide integrated devices that are designed to work together.
The traditional telecommunications equipment makers also have sales and marketing forces that can reach around the world, serving a base of existing customers that dwarfs whatever Tekelec can muster.
Lingering on the horizon are some unresolved technological issues that could impact the market. Tekelec, for example, has proposed a communications standard to link various digital devices to the telephone network. Nortel has put forward a competing version.
Tekelec concedes that its size can be a disadvantage. It needs the help of partners such as Lucent to help sell its products in new markets, particularly overseas, where Alcatel and Nortel are strongest.
The David-and-Goliath scenario has made Tekelec the target of perennial rumors that it will be acquired, usually with the same suitor mentioned, Cisco Systems.
But Margolis said, “We weren’t created to be sold, and our philosophy is to build a company.”
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Tekelec Inc.
AT A GLANCE
* Products: Tekelec makes telecommunications network equipment and diagnostics systems focused on a key piece of the telephone network known as Signaling System 7.
* Headquarters: Calabasas
* NASDAQ symbol: TKLC
* CEO: Michael L. Margolis
* Founded: 1979
* Initial public stock offering: 1986
* Number of employees: 925
* Current market capitalization: $2.5 billion
* 1999 revenue: $226 million
* 1999 net income: $440,000
