BUYS AIM AT TOP OF VENDOR FOOD CHAIN

Lucent’s acquisition of Telica last week and Tellabs’ purchase of AFC the previous week both fit the old pattern of big traditional telecom vendors buying aggressive smaller companies to capture market share in a hot sector. But both acquiring companies claimed things are different this time around.

Instead of paying for market share, both companies said the synergies make the acquisitions logical extensions of their existing product lines. If so, vendors could be standing on the precipice of a long string of M&A activity that will put the largest players in greater competition with each other, shuffle market share in the access and switching sectors and blur the lines between what were previously distinct markets.

Most analysts agreed that the $1.9 billion in cash and stock that Tellabs paid for AFC was a bargain, while several questioned Lucent paying $295 million in stock and options for Telica. The similarities between the two deals, however, are striking.

For the money, Tellabs’ acquisition of AFC means significant market share in the access network equipment sector, a lead role in the emerging telco video market and an enviable position as an early lead vendor for Verizon’s fiber-to-the-premises rollout. At the same time, the deal gives AFC a big brother to make introductions into larger carrier accounts.

“The dialogue I’ve had with customers has been extremely positive,” said John Schofield, CEO and president of AFC, who will take on the role of chief operating officer of Tellabs. “The large customers I’ve talked to recently said to me that they view this as a one-plus-one-equals-three combination.”

The acquisition also completes a notable strategic shift for AFC, which just recently closed its own acquisition of Marconi’s access line. Previously, the company relied largely on the independent operating company market. And while Schofield and recently appointed Tellabs CEO Krish Prabhu vowed to continue serving those small ILECs, the merged company will have bigger fish to fry, according to several competitors. “AFC had already begun to move away from its roots, so it’s not surprising,” said one vendor executive who requested anonymity.

Corey Geiger, AFC’s former vice president of product management and marketing who last week took the position of vice president of marketing for Pedestal Networks, said that AFC becoming part of a larger entity does not pose a competitive threat to smaller, more focused vendors. “We don’t intend to be a huge systems supplier,” Geiger said of Pedestal. “We intend to stay focused on the access market.”

Other access vendors said the move represents a natural evolution for AFC. “The kind of company that AFC was needs to move onto the next generation of the network and away from lower layers of the stack,” said Seth Kenvin, vice president of corporate development for BigBand Networks.

For Tellabs, however, the deal hints at some larger ambitions. From a product line perspective, Prabhu did his best to sell the merger as one that would produce synergies between Tellabs’ Titan cross-connects and AFC’s AccessMax platform and Telliant video router.

“Customers today are buying the products under separate supply agreements, and I think they are interested in cutting [down the number of suppliers],” Prabhu told Telephony on the day the deal was announced. “In the longer term, we can leverage the trends of these two complementary product lines.”

However, turning Tellabs from a conservative gear supplier into a dominant vendor will require more expansion. Many observers believe the next logical step is entry into the softswitch market. Ironically, Tellabs was one of the first large vendors in the softswitch market when it spent $300 million in stock in 2000 to acquire Salix Technologies, which was subsequently shuttered.

“If you look at the lineup of full-line suppliers, I thought Tellabs would definitely be there,” said John Celentano, president of Skyline Marketing. “They were way ahead of their time when they made that acquisition.”

Though it is possible Tellabs could resurrect Salix, acquisition would be the more logical route, Celentano said. But finding an independent softswitch vendor could be difficult.

Lucent’s acquisition of Telica took out one of the few strong independent players left. The deal gives Lucent a softswitch architecture that has been deployed by 50 carrier customers worldwide—including Verizon, which earlier this year gave Nortel Networks an 18-month exclusive contract for Class 5 circuit switch replacements. Lucent will integrate Telica’s architecture into its Accelerate platform, which was recently selected by BellSouth as part of the carrier’s transition to packet switching.

For the moment, Lucent also is looking at Telica’s Plexus softswitch platform as a pumped-up extension of its small iGen switch, which is aimed at low line-count applications.

“One thing that’s different is that the iGen can support two-wire line terminations on a line card, where Telica can support GR303,” said Ron De Lang, vice president of Lucent’s Convergence Solutions Group.

Lucent had looked at developing something similar to Plexus internally, but was being pressed to come up with something soon, said Janet Davidson, president of Lucent’s Integrated Network Solutions business. “Time to market is critical, and this market is happening now,” Davidson said during a call with analysts last week. “The RFPs are happening, and people are moving to deployment.”

As with Tellabs’ AFC acquisition, Telica gains the Lucent name, which certainly opens doors that are more difficult for smaller entities to crack. The Marlboro, Mass.-based Telica was on the verge of filing its S-1 to go public when the Lucent deal came about. Deciding to sell to Lucent, however, made more sense, said John St. Amand, CEO of Telica.

“A big goal of mine was figuring out how I turn this into a billion dollar company,” St. Amand said. “It really put us in a position to control the VoIP market.”

Telica and Lucent’s competitors in the switching market see opportunity in the transaction—another similarity to the Tellabs/AFC deal. “Not everyone has had a great experience with Lucent over the past five years,” said Andy Randall, vice president of marketing for MetaSwitch. “We have customers who went down the PathStar route and never want to see a red circle in their building again. There’s always a halting stumble when a company is acquired.”

Lucent CEO Pat Russo, in making the announcement, indicated that the company would continue expanding its product breadth through acquisition, internal development and possibly alliances. Oddly enough, one of the areas in which analysts see Lucent lacking is the access market.

In a research note after the acquisition, Celentano noted that the line between access and switch vendors is blurring.

“The loop access equipment and the vendors that supply it are going to start running into the switching guys,” he wrote. “We should expect to see more consolidation.”