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September 19, 2005 Memphis, TN -- Simon M. Leopold, an analyst at investment and financial services firm Morgan Keegan, today issued the following statement on behalf of the firm:
"We believe that Verizon selected Tellabs as its sole initial supplier for next-generation optical equipment, which comes as a big surprise. This win gives Tellabs a new growth engine in a project we value at $250 - $350 mm over several years. We upgrade Tellabs to 'Outperform.' This win makes Tellabs a contender in the recovered optical systems market with bragging rights on the leading edge."
A press release issued by the firm states that "multiple channel checks suggest that Tellabs has won Verizon's Optical Transport Platform (OTP) RFP, and will serve as sole initial supplier for Verizon's next generation core optical transport equipment based on reconfigurable optical add-drop multiplexing (ROADM) technology with a project worth $250 - $350 mm over 3 years."
The firm says that its surprise at its findings stems its own previous analysis, which suggested that "Fujitsu led this race ahead of Cisco and Tellabs." In contrast, the firm now forecasts that "incumbent Lucent's EON metro optical gear will be displaced by Tellabs."
"This win is material to Tellabs," confirms Leopold. "We believe that Tellabs' ROADM is a new product based on its 7100 platform. BellSouth provides most of the 7100 revenue now ($53 mm or 3% of 2005E sales of $1.9 billion in our view), so Verizon will certainly help improve the top-line."
Further, the firm reports that its "contacts suggest that pricing was paramount in winning this business - and it may pressure margin." Regarding the findings, the firm says that its "surprise is [also] based in part on Tellabs' lack of an ROADM offering prior to this RFP," while warning that "risk remains should there be glitches in initial rollout." The firm also notes that Tellabs' ROADM platform must complete network management integration including Telcordia's OSMINE process, and suggests that "software integration could delay revenue until 2H06."
In upgrading its rating of Tellabs to "Out Perform" from "Market Perform," the firm reports that its "model adjustments reflect $50 mm incremental optical sales in 2006 plus increased R&D expenses to reflect the network management integration expenses," with further adjustments made "to reflect mix shifts and hurricane repairs." The firm holds that its 2005 estimates for the company remain unchanged, and sees the company's 2006 sales rising to $1.982 billion from $1.926 billion, with earnings per share rising to $0.47 from $0.43. The firm notes that the stock's "valuation looks good on several metrics including the lowest enterprise value to 2006 EBITDA of 7.4x in the peer group at 11.2x."
The firm says that Tellabs' perceived win at Verizon leads the firm to see the vendor "in a better light," noting that several of the company's businesses have improved this year, including its Fiber to the Curb (FTTC) win at BellSouth and continued sales in support of Verizon's FTTP initiative. The firm also observes that Tellabs' 2005 data networking business "looks better with Cable & Wireless and MCI sales this year, and Verizon ramping next year."
However, regarding Tellabs' prospects, the firm cautions that "several areas of weakness or vulnerability have received less attention," noting that the company's wireless carrier sales "remain a risk on a dollar basis with nearly 25% of sales coming from DCS into wireless carriers." The firm also says that the company's "international sales look troubling," citing Asian competition in Asia from vendors such as Huawei and ZTE, as well as significant European competition from Alcatel and ECI Telecom. For Tellabs, the firm concludes that, "weakening sales of access gear to non-RBOC accounts remains likely," noting that such declines may ultimately detract from the company's year-end results.
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