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Tellabs Buys California Firm to Provide More High-Speed Internet Connections

Posted on: Thursday, 20 May 2004, 06:00 CDT

May 21--In a long anticipated move, Tellabs Inc. on Thursday bought a California firm to meet the growing demand for high-speed Internet connections.

The deal, which was valued at $1.69 billion after Thursday's market close, sent Tellabs' shares down more than 13 percent.

But with a billion dollars on its balance sheet, the Naperville telecom equipment maker has been shopping for a company like AFC so it could provide end-to-end broadband network connectivity for customers such as Verizon Communications Inc. and SBC Communications Inc., said Chief Executive Trish Prabhu. Advanced Fibre Communications Inc. specializes in supplying optical fiber to the home.

"This gives us a fuller, more complete product line," said Prabhu.

The deal, which was valued at $1.9 billion when it was announced Thursday morning, is a bold step for Tellabs. The company has struggled with falling sales, factory closings and layoffs that shrank its work force by nearly two-thirds during the sharp drop in telecom spending following the dot-com collapse.

Last month, Tellabs posted its first quarterly profit in two years.

The acquisition is a bet that large phone companies are serious about upgrading their networks to carry high-speed data that can carry voice, e-mail and now video. To do so, the phone companies need to bring optical fiber to their customers' premises instead of copper wires.

Last year the Federal Communications Commission adopted rules to encourage fiber build-outs by exempting the new technology from most traditional regulation.

Earlier this week, Verizon rolled out a fiber service in Keller, Texas, using AFC products. Keller, a town of 30,000, will get data service that runs ten times faster than digital subscriber line service -- or DSL -- for about the same price sometime this summer. The service will also provide 150 television channels and Internet protocol video, said Verizon spokesman Eric Rabe.

Verizon plans to have fiber connections to 1 million customers by the end of this year and to 3 million by the end of 2005, he said. After "five years, we plan to have one-third of our customer base -- about 12 million premises -- equipped with fiber."

Cable television operators already offer high-speed Internet in competition with DSL from Verizon and SBC. Furthermore, the cable companies plan to offer Internet telephony in direct competition with the phone companies' core product.

Albert Lin, an analyst with American Technology Research, said that to stay competitive, the phone companies must upgrade their networks to fiber.

"If they're going to compete with cable, they have no choice but to put in fiber," said Lin. "Tellabs is doing the right thing, buying AFC."

The key to success for Tellabs will be to reduce the costs of installing fiber, said Jim Andrew, a vice president with Adventis, a Boston telecom consultancy.

"I know the phone companies want to do it," said Andrew. "It's just a matter of getting the costs down to where the models start to work, and they're not far off now. A reduction of 20 percent or so would do it. Verizon is already committed to spending $3 billion on this, so the volume from that business should help cost reduction."

The merger has been approved by the boards of both Tellabs and AFC but awaits shareholder approval of each firm. Terms call for AFC stockholders to receive 1.55 shares of Tellabs common stock and $7 in cash for each AFC share.

Based on Thursday's market close, AFC shareholders would get $19.32 a share, not $21.24 a share when the deal was announced earlier in the day.

Tellabs' shares fell $1.24 to close at $7.95 while AFC's share price rose $2.13, or more than 12 percent, to close at $18.96.

Such price fluctuations are typical when a merger is announced, said John Schofield, AFC chairman. "I don't perceive any problem," he said. "Usually, the stock trades back to its old value by the time shareholders vote."

When the deal closes in the second half of the year, Schofield is expected to become Tellabs' chief operating officer. He and two others from AFC will join Tellabs' board, which will expand to 12 slots.

Current Tellabs stockholders will own about 75 percent of the combined company and AFC stockholders will own 25 percent. The total number on Tellabs' payroll will rise to about 4,100 from about 3,150 now.

Prabhu said Tellabs management will concentrate on integrating AFC into its organization when the deal closes.

"We don't anticipate making any other acquisitions in the near future," Prabhu said.

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(c) 2004, Chicago Tribune. Distributed by Knight Ridder/Tribune Business News.

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