Sycamore acquires its way to the edge

Optical equipment vendor Sycamore Networks has agreed to acquire Eastern Research, a New Jersey-based vendor of edge networking equipment. The move gives the optical core vendor a portfolio of products at the network’s edge.

Sycamore will pay $8 million in cash and 17.8 million shares of stock for the acquisition for a total of about $92.5 million.

The fact that so much of the deal is stock-based is surprising given Sycamore’s wealth of cash. At the end of January, Sycamore had $965.8 million in cash and investments. Though using so much stock in the deal dilutes the value of current shareholder investments, it was done mainly to help Eastern’s parent company, Allen Organ, qualify for the cash-free reorganization it is simultaneously conducting. The deal’s structure also helps Sycamore save more cash for potential future acquisitions, Sycamore’s chief financial officer Richard Gaynor said.

Sycamore and its new purchase share no product overlap, according to the two companies. Eastern Research sells multiservice crossconnects and access gateways that groom, aggregate and manage access traffic. Its customers include Tier 1 wireless and wireline carriers, utility companies, government agencies and the military. Among them are Australian carrier Telstra and the U.S. Federal Aviation Administration. The company employs 250 people and reported $62 million in revenue for 2005. The vast majority of that revenue came from direct sales to U.S. customers. About a third came from wireless carriers.

Sycamore plans to continue selling and developing all of Eastern’s products, eventually imbuing them with the network intelligence that is a trademark of its own core switches. In the near term, Sycamore expects the addition of Eastern to boost its top line significantly, as Eastern’s fiscal 2005 revenue was almost equal to Sycamore’s.

In a conference call late Wednesday announcing the deal, Sycamore executives also touted Eastern’s impressive gross margins as uncharacteristic of typical access vendors. In 2004, Eastern’s gross margins were 58%; last year they were 62%.

Sycamore’s executives attributed those margins to the exceptional ability of Eastern’s employees to add value by being attentive to its customers’ system development needs.

Sycamore expects the deal to close this summer and be accretive on a quarterly basis, excluding one-time merger costs, within a year after that.