For Tellabs, a Little Caution Creates a Lot of Selling

It's easy to find bulls who insist telecommunications supplier Tellabs (TLAB) is not about to encounter a sea change in spending by its customers. But with its stock price falling, Tellabs is under increased pressure to bring its new offerings to fruition this year.

Early Tuesday, Tellabs reported strong profits for the fourth quarter ended December but said it might fall roughly 10% short of expectations in the current period. The company is investing more heavily in sales and marketing efforts, as well as selling new products that fetch lower margins. It also expects to receive less favorable tax treatment overseas. And its mainstay products, referred to as "digital cross-connects," might not generate enough growth to pick up the slack.

Tellabs slipped 9 9/16, or 14%, to 59 1/2 on heavy volume Tuesday.

The company's stock has not participated in the run-up of other telecom suppliers such as Nortel (NT) and Cisco (CSCO), which have benefited from investor enthusiasm for a new generation of optical-network technology. While Nortel, for one, has acquired numerous Internet-focused companies, Tellabs has moved slowly and bought selectively. It has stayed the course quarter after quarter, posting strong sales and defying the notion that phone companies would quickly shift to advanced fiber optics and abandon their old-fashioned ways.

Tellabs' cautious words Tuesday, coming fast on the heels of Lucent's (LU) troubling disclosure early this month, rubbed a raw spot with investors. Rattled boosters believe that Tellabs' core products will keep selling and that its new offerings are viable.

"Over the last five years, whenever [the stock] has had a hard dip, it's always been a buying opportunity," says Chandan Sarkar, who covers telecom-equipment stocks for SoundView Technology Group. That's still the case, says Sarkar, who rates Tellabs a buy and whose firm has no banking ties to the companies discussed.

"These guys have always kind of been viewed as a one-trick pony," Sarkar says. "And now they have a new line of products." Analyst Steve Levy with Lehman Brothers (also not an underwriter for Tellabs) expects the company to generate about $160 million of its total $3.1 billion in revenue in 2000 from four new products, including a network switch from its acquired NetCore division. Tellabs' other offerings will help telephone companies shuttle voice calls in digital packets and run multiple beams of light through one fiber.

Tellabs earned $168.1 million, or 41 cents a share, in the fourth quarter ended December, beating analyst estimates by a cent, compared with $121 million, or 30 cents a share, one year earlier. The fourth-quarter results exclude a pretax gain of $29.9 million from selling an investment. Revenue grew 37% to $714.9 million from $521.3 million. Tellabs stock slipped in heavy trading as investors reacted to executives' comments that the company likely will make 30 cents a share in the March quarter, about 3 cents less than expected. It still expects to earn the anticipated $1.68 a share in the full year.

Historically Tellabs has encouraged analysts to raise their estimates, according to analyst Paul Silverstein with Robertson Stephens, which has not acted as an underwriter for the companies discussed. This time it didn't. "I think that is the bulk of the disappointment," he said.

One longtime investor says Tellabs is just showing extreme caution.

"In my view, it was really poorly communicated guidance," says Ned Brines, portfolio manager with Roger Engemann & Associates, a shareholder of Tellabs and other telecom suppliers such as Lucent. Brines says the company's performance proves once again that telephone companies continue to purchase plain electronic network systems even as they demand new fiber-optic technology from stalwarts such as Nortel.

In time -- and the bull vs. bear fight hinges on when -- telephone companies will be more interested in expanding their networks without Tellabs' digital cross-connects. John Roth, CEO of Tellabs partner Nortel, likens these cross-connects to the on- and off-ramps of a highway. New fiber-optic technologies, he says, are putting these passengers onto speedier paths. Eventually "you don't want all those on- and off-ramps. They're just a nuisance." Nortel reported strong sales late Tuesday, thanks partly to robust sales of fiber-optic products.

The dramatic selloff of Tellabs reflects the high standards of investors, who have come to expect only positive surprises in telecommunications.

"In this market, anytime you say a little caution is appropriate, people are going to bail," says Michael Birck, CEO of Tellabs since 1975. But when investors recognize Tellabs' endurance, he says, they'll return.

In a twist of investor fancy, Tellabs stock now lags the fiber-optic supplier Ciena (CIEN) (even after adjusting for a stock split by Tellabs last year) for the first time since their merger-of-equals unraveled in September 1998. Tellabs canceled the deal after Ciena lost prospective contracts with customers, including AT&T (T). Today Ciena is executing a turnaround, developing higher-margin optical products through its acquired units Omnia Communications and Lightera Networks.

Like Ciena, Tellabs seems most likely to regain Wall Street's favor by getting new products out the door as well.

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