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Tellabs takes the Net one step at a time

Tellabs is shifting from making old-line telecom equipment to supplying gear for the "convergence" market, challenging industry giants in the process.

The Internet is pulling along even the unlikeliest of companies.

Tellabs, a nearly 25-year-old firm specializing in old-line network equipment used by communications carriers to keep phone networks up and running, is quietly making the shift to the "convergence" market and is challenging industry giants in the process.

With its recent acquisitions and strategy shift, Tellabs is in vogue on Wall Street, growing at a rate of 30 percent a year with a soaring stock price that is near record highs following a recent stock split. Since the beginning of this year, the company's stock price has more than doubled.

Tellabs built a billion-dollar business making switching equipment and associated management systems. Those systems sit on a communications carrier's network and essentially act as a "traffic cop," routing circuit-based transmissions to business and residential customers.

But recently, Tellabs has come to a crossroads. As new methods of delivering data and voice across a network are introduced, many carriers are considering moving toward a network based on the new protocols that treat voice and data as "packets" and "cells."

In the past, carriers have had to establish connections using dedicated circuits between two points. By using packets, information--in the form of data, voice, or video--can be broken up, sent across a network at high speeds, and re-assembled at the other end of the connection.

Simply put, telecommunications firms are embracing the Internet, choosing to incorporate the underlying technologies of the medium to cut costs and simplify their network layouts.

Thus Tellabs, as well as other companies, has been grappling with a crucial issue: How quickly should it transition strategies and technologies to meet the demand for packet-based networks?

While competitors such as Cisco Systems, Lucent Technologies, Nortel Networks, and Alcatel have spent considerable time and energy articulating their strategies to the market, Tellabs has quietly chugged along, seemingly immune to the industry fervor surrounding the convergence of standard telephone systems and new Internet technologies.

Recent deals show the company isn't in the dark, however. Tellabs purchased high-speed routing upstart NetCore Systems last month for $575 million. The deal represents the firm's first step toward an Internet strategy based largely on internal product evolutions.

"If you don't cannibalize your own, somebody else will," said president and chief executive Michael Birck in a recent interview. "It's an implementation change, not a philosophical one. If we don't keep pace, we could have some revenue issues.

"It's what you have to do," he said.

Instead of barreling ahead at Net speeds, Tellabs has adopted the slow and methodical strategy of many of its traditional telecom customers for transitioning its products to the world of packet-based Internet systems.

"Nothing in this industry has ever happened overnight," said Steve Kemp, a marketing manager within Tellabs' adaptive network solutions division. "We have a good record of delivering on what we say we're going to do."

The company's pragmatic approach to this networking market evolution has won many fans on Wall Street who thankfully have quickly forgotten Tellabs' failed merger with Ciena last fall.

Analysts also have high hopes that with new technology, Tellabs will bridge its circuit "cross-connect" systems with new packet-switched technologies. "They are adapting their products," noted equities analyst Chris LeBlanc of Bank of America Securities.

LeBlanc said the firm is well respected for taking a conservative approach to market expectations and enjoys a solid base of customers in two key segments: regional Bell operating companies, or RBOCs, and long distance carriers. LeBlanc also noted that the firm has been "more visible with their strategy going forward" in recent months, a fact reflected in their current valuation, he said.

Over the course of the next year, Tellabs is expected to debut a new gateway to tie its traditional technology to network layouts based on asynchronous transfer mode, or ATM--a favorite transmission method for service providers. It also plans to add density to its traditional cross-connect switches and add management systems for broadband networks, eyeing the rapidly emerging cable networking opportunities, according to analysts.

The niche that would have been filled by Ciena--dense division wave multiplexing, or DWDM--is slated to debut next year.

That said, Tellabs--with $1.6 billion in revenue for its most recent fiscal year--remains a small firm on a networking landscape. Even leaders like Cisco could be seen as small in the shadows of giants such as Lucent, Nortel, Alcatel, and Siemens.

"They're clearly challenged because they don't have the resources of their competitors in the market," said Jeremy Duke, analyst with the Synergy Research Group.

But Tellabs' pace may provide the salve that soothes Wall Street in an era where companies can rapidly lose billions of dollars in market value.

"We aren't going to do anything radical in these areas," cautioned Tellabs' Birck. "We certainly choose our market opportunities."