Mergers seen as natural in a maturing fiber industry

Aug. 1, 1998

Mergers seen as natural in a maturing fiber industry

Is your head spinning from the latest merger announcement? Hold on to your seat.

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."

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."

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."

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. u

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