Will the spinoff trend continue?

TRENDS

By ROBERT PEASE

An intriguing trend in optical telecommunications began taking shape over the last few years. Along with an incredible number of optical startup companies with an astounding amount of financial support from venture capitalists, several large telecom companies spun out new entities from their optical business interests. These "new" optical players entered the arena with some distinct technology and financial advantages over their startup competitors. With differing philosophies, motivations, and ties to the "mother ship," each is challenging the competition in their particular optical market niche.

In December 1999, Ericsson (Stockholm) introduced Metro-Optix (Plano, TX), an optical-network equipment provider focused on the metropolitan market. Nine months in the making, Metro-Optix resulted from an Ericsson decision to focus more on its third-generation wireless business. With $20 million in venture capital and $14 million from Ericsson, the company grew quickly to about 300 people with $83 million in funding today. Ericsson holds a 17% interest in Metro-Optix but does not have a seat on its board of directors.

"Ericsson executives and I believed that the product development could be fast-tracked in a much shorter time frame if our company and product development were self-sufficient and able to move more freely and make faster decisions," says Arun Bellary, CEO and chairman of Metro-Optix. "We also used the parent to ensure we had the customer traction. There's a lot of false hype in the marketplace about spin-outs, and we think our product really helps redefine the value of spinning out of the parent company."

Bellary points out a key benefit has been the company's established customer base-one that is large, stable, and requires months of engagement before making a sale. Metro-Optix had the advantage of selling the concept two years ago. The company boasts a strong management team as well.

By being more independent, Metro-Optix believes it can react more quickly to the marketplace and make major decisions without having layers of approvals to slow down the process. "We can focus on a niche-addressable market, and we don't have to be all things to all people," says Bellary. "The success of a spinoff depends on the strength of its business case, technology, network topology, and cost differentiators as well as the ability to attract and secure the correct customers. Our business model is soundly based on doing business mostly with the blue-chip IXCs [inter exchange carriers] and CLECs [competitive local-exchange carriers] initially and later ILECs [incumbent local-exchange carriers], since they have a longer approval cycle."

To create an organization focusing exclusively on optical networking and gain a strong foothold in the North American market, Siemens formed Optisphere Networks in April 2000. Although Optisphere may not be a true spin-off in every sense because it remains a wholly owned subsidiary of Siemens's Information and Communications Networks Inc., the new entity is capitalizing on the parent company's corporate structure, financial backing, and organizational resources.

"A separate entity creates focus, the ability to be more responsive to customers, and the opportunity to institute more novel business practices to help the company succeed," says Optisphere CEO Jost Spielvogel. "From an internal business perspective, when you establish a separate company, you can determine the true value it delivers to its owners."

The Siemens/Optisphere story is somewhat unique, says Spielvogel, because the new company was formed exclusively through acquisitions and has operated at "arms length" from the parent company since inception. While many spinoffs are the result of companies shedding their optical components businesses, Optisphere was formed as a clear management decision to "hyper-focus" on a specific growth market and, initially, in a distinct geographical area. The idea is to take a home-grown approach by building a frontier startup environment and blending it with the backing of a global company.

One of those large companies that shed its optical component business was Lucent Technologies, which announced the spinoff of Agere Systems from its microelectronics group in July 2000. Agere was formed to develop and manufacture optoelectronic components through its optoelectronic division for long- and short-haul communications networks.

In a similar vein, one of the newest spinoff companies made its debut at this year's Optical Fiber Conference in Anaheim, CA. OpNext was formed in September 2000 from Hitachi's fiber-optic components business unit. According to Harry Bosco, CEO at OpNext, Hitachi realized there were substantial growth opportunities within the optical communications industry beyond the business unit's current scale.

"Taking advantage of those opportunities would mean global expansion, investment, and quite possibly, acquisitions," says Bosco. "As such, a globally oriented, focused optical component business was more likely to succeed rapidly. In addition, access to additional capital would accelerate growth and achieve greater market recognition of the business's value."

Currently, Hitachi retains a majority ownership, and OpNext has not been publicly floated. Bosco believes the success of OpNext will derive from expanded sales and marketing to support close relationships with customers, world-class technology development, global investment, and access to capital. "It makes sense to do this as a free-standing unit with the drive, flexibility, and responsiveness to create major shareholder value for investors," says Bosco. "Also, a components entity independent of a systems parent is more likely to be able to sell components to other system-provider customers."

Bosco also sees the optical components industry as a "business in its own right," rather than as a subsidiary of the telecommunications systems industry. That may account for the number of large companies spinning off their component businesses as separate units. He also believes that as Lucent did with Agere, there will be more publicly floated spinoff component companies to come.

Network carriers are also entering into the "spinoff" trend. As recently as last March, Williams announced plans for spinning out Williams Communications. According to Williams, it was the next logical step for the company to provide superior value to its shareholders through operations, technology, and leveraging an already completed next-generation fiber-optic network to generate revenue.

Says Howard Janzen, president and CEO of Williams Communications, the spinoff will enable the pioneer company to solidify its market presence and focus solely on supporting the needs of bandwidth-centric businesses. "Just as important," adds Janzen, "the move enables us to fortify our competitive advantage as the only broadband network services provider to focus on bandwidth-centric customers while not competing with them."

With the recent slump in the telecommunications market, will companies still be inclined to spin out new entities with the same hopes of success? It's painfully obvious that the past flow of the venture capital faucets has slowed in terms of funding telecommunications startups-even if they have "optic" in their title. The question is whether to spin or not to spin?

Robert Rosenberg, president of In sight Research Corp. (Parsippany, NJ), a telecom research company, believes the tendency to spin out new companies can't help but be a product of the economy. Therefore, if the economy is depressed, particularly in the technology sectors, companies will likely adopt a more "wait and see" strategy before deciding to spin out an optical unit.

"The duty of the executive officers in all of these companies is to increase shareholder value," says Rosenberg. "Yet, we've seen things begin to unravel a bit in the industry with the economic downturn around the fourth quarter of 2000. The venture capitalists looking to pull their money out in two years will have to start realizing there is a new time schedule. For the immediate future, larger companies that are taking optical units that they've either developed internally or acquired themselves will likely just sit on those assets for a while."

Rosenberg thus predicts a slowdown in optical spinoffs. Previously, markets may have "over-valued" these optical units, so it was incumbent upon the executives to spin them out to increase shareholder value. But Rosenberg believes those days are over-at least for now-and it will be at least 18 months before this trend would pick up again.

"It seems to me that you spin a company out because it will have a higher valuation than if you held onto it internally," says Rosenberg. "But with the entire telecom sector depressed right now, it's more likely that if you've got an optical unit that's doing well, you'll hang onto it. There isn't much money out there to capitalize on with a new spinoff company, so holding onto the asset and revisiting it when the economy turns around seems like the logical strategy for a large company today."

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