Tellabs digests AFC

With Tellabs’ acquisition of Advanced Fibre Communications officially closed as of last night, Tellabs executive vice president and chief financial officer Tim Wiggins spoke to analysts and investors at a Credit Suisse First Boston conference today, providing detail on some of the issues afflicting AFC in recent months.

The value of Tellabs’ purchase of AFC ended up at about $1.5 billion ($1.1 billion in cash and about 45 million shares of Tellabs stock worth roughly $385 million), down 21% from the original price of $1.9 billion announced in May but consistent with the revision announced in September.

The company expects to be able to cull between $16 million and $60 million in synergies by combining the two companies in addition to allowing Tellabs, a traditional transport player, to enter the access and fiber-to-the-premises (FTTP) markets and giving AFC bigger shoulders and a deeper relationship with major American incumbent carriers.

“We believe the integration process is already well under way, and, given the company’s other recent acquisitions (e.g., Ocular and Vivace), we are optimistic that the transaction should proceed smoothly,” Lehman Brothers analyst Steve Levy wrote in a research note issued today. Levy predicted Tellabs will realize about $30 million in operating synergies next year.

Earlier this week, Tellabs announced that AFC chief executive officer John Schofield would not take a seat on the merged company’s board of directors, as had originally been planned. Instead Schofield will step down from the company, citing “family reasons”, and his board seat will be filled by Frank Ianna, who has been an AFC director since February. According to documents filed with the Securities and Exchange Commission, Schofield was to receive three times his annual salary and target bonus if he were terminated without cause or resigned within 18 months following the merger. Based on Schofield’s 2003 salary of nearly $452,000 and bonus of nearly $496,000, that amount would equal roughly $2.8 million.

In connection with the closing of the merger, Tellabs announced three new executive appointments: Carl DeWilde, formerly of ultralong-haul equipment vendor Xtera, was named Tellabs new executive vice president for access products. Jeff Rosen, AFC’s former vice president of operations and customer service, was named executive vice president of operations and given responsibility for Tellabs’ global supply chain. Victoria Perrault, AFC’s former vice president of administrative services, was named executive vice president of human resources.

Supply chain issues that have dogged Tellabs in recent quarters as one of its vendors moved manufacturing facilities from Finland to Estonia will probably persist for another quarter or two, Wiggins said today. “Supply chain problems are complex and don’t go away immediately. There’s a lot of screaming and yelling that goes on between you and your outsource guy. We’re working that strenuously.”

In response to an analyst question, Wiggins said that AFC had renewed its focus on independent operating companies after having been distracted by its role as a supplier to Verizon Communications’ broad FTTP initiative. “AFC…in some ways took their eye off that ball and said, ‘We’ve got a new friend and that new friend is very demanding in terms of time,’” Wiggins said. “AFC has already gone back and refocused on this area. They’ve stabilized that. The feedback from IOC customers has been, ‘Glad to see you’re back; glad you’re paying attention to us.’ I think we’ll add to that. While that’s not a giant marketplace, it’s a good business.”

Wiggins also addressed the low margins AFC has been experiencing with its optical network terminals (ONTs), the devices that sit at the customer premises in a FTTP network, by hinting at the use of other vendors’ equipment. “You can’t get the prices where the business model needs them to be without volume,” he said. “But until six months ago, no one believed that fiber was going to happen. AFC said, ‘We want the business badly enough; we’ll forward-price the ONT on the assumption it will take much longer to roll this out than they tell us. Everyone’s been surprised by how aggressive Verizon’s been. The volume has been significantly higher than they expected. The $64,000 question is: How important is it to our customers that the ONT comes from same supplier as the OLT [the optical line terminal, which sits in the central office or remote terminal]?”

Wiggins expressed confidence in the ability of Tellabs employees--specifically those involved with its Cablespan product who have familiarity with customer premises equipment--to ameliorate the ONT situation. “I’m excited about turning loose more resources on it,” he added.

AFC has already completed interoperability testing with two vendors that could be used as a second source for AFC’s ONTs, Levy wrote. “This…is important as it should reduce some of the negative gross margin pressure on AFC’s FTTP business.”

Merger talks between AFC and Tellabs began in early February 2003, when Schofield met with Michael Birck, the founder of Tellabs who was then also CEO.