Networkers Return to the IPO Well

After three years of network-equipment companies preferring M&A to IPO, the trend appears to be reversing.
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SAN FRANCISCO -- Networkers, sniffing riches, are waking up to the IPO market again.

On April 9,

Extreme Networks

(EXTR) - Get Report

in Santa Clara, Calif., raised $136 million by issuing 8 million shares at 17 a share. The stock promptly tripled in price to 55 3/8 in a day. It's since settled at 42 1/8, valuing the 3-year-old company at $2 billion, or 41 times its sales last year.

That's just the beginning.

Copper Mountain Networks

and

Redback Networks

intend to raise $47 million and $30 million, respectively, on the public markets, although no dates have been set. On Wednesday,

Juniper Networks

filed documents to offer stock worth $70 million.

The burst of IPOs ends a dry period for builders of network equipment, dating back to

Xylan's

(XYLN)

post-IPO fizzle in 1996. Offered at 26 a share in March, Xylan had surged to 76 by May, but slumped below 10 by late last year amid worries about competition from mighty

Cisco

(CSCO) - Get Report

.

Alcatel

(ALA)

bought Xylan early this month for roughly half its previous share price.

Since then, rather than going public, most successful networking-gear start-ups have folded into large competitors such as Cisco,

Nortel

(NT)

and Alcatel. Doing so is presumably the best way to win the business of established carriers such as

Bell Atlantic

(BEL)

and

AT&T

(T) - Get Report

. "In many cases, there's more economic benefit to the start-up to insert their products into an existing channel than to do it on their own," says analyst Greg Collins with market researcher

Dell'Oro Group

.

For their part, U.S. and European acquirers are trying to plant themselves in future markets. The trend started in 1993 with Cisco's purchase of

Crescendo

for the then-unthinkable price of $90 million. Crescendo launched Cisco into the nascent switch business. Cisco hasn't disclosed how much switches contributed to its $10 billion in revenue in the past 12 months, but analysts say it's a considerable portion.

This spring, a few start-ups are resisting being bought up early, trying instead to grow independently by selling products to young carriers such as

Qwest

(QWST)

and

Level 3

(LVLT)

. Deregulation has spawned many experimental carriers worldwide.

"You can really build a large company" by courting such clients, says Spencer Punter, associate with the money manager

Integral Capital Partners

in Menlo Park, Calif.

For example, last month Chelmsford, Mass.-based

Sycamore Networks

convinced

Williams Cos.

(WMB) - Get Report

to order $24.5 million of its optical-fiber systems. Sycamore CEO Dan Smith says the company can thrive independently partly because its salespeople have trusted reputations in the industry. He is not making plans to be acquired. Integral has a venture-capital stake in Sycamore.

So rather than enlisting M&A specialists, up-and-coming networkers are talking to underwriters. Extreme's IPO illustrates that Wall Street is willing to stomach their scrappy P&L statements.

Extreme and Copper Mountain eked out profits of $400,000 and $587,000, respectively, in the March quarter -- their first profits ever. Both Juniper and Redback saw net losses widen -- Juniper's $6.7 million loss compares with a loss of $3.9 million one year earlier, while Redback's loss grew to $3.8 million from $2 million in the same period.

Juniper personifies the risky, bullish story of a networking start-up. Owned partly by

Ericsson

(ERICY)

and Nortel, Juniper's huge M40 router notched sales of $10 million last quarter. Juniper has signed contracts with

MCI WorldCom

(WCOM)

and

Cable & Wireless

(CWZ)

.

With such marquee clients, Juniper is "not an ephemeral .com play," says analyst Gail Bronson with

IPO Monitor

research service.

The IPO route has some downsides: Once a company goes public, it's hard to shift strategies and seek a takeover because the demand for publicly traded shares of networkers these days is usually strong enough to push up a company's valuation -- and therefore its price tag. Extreme now costs more than $2 billion.

And while an IPO might spin gold for the founders once the six-month lockup period ends, some in the industry question whether it makes more competitive sense than a buyout.

Longtime entrepreneur Wu Fu Chen took the old M&A path, deciding after seven months of partnership talks to merge his company,

Shasta Networks

, with telecom supplier Nortel for $340 million in stock and cash. Chen, a Cisco veteran who has started and sold several networking companies, figured this was the best way to reach Nortel's customers.

Some experts expect the number of networking IPOs to taper off. Andy Rachleff, partner with venture capital firm

Benchmark Capital

, says the IPOs are "more of a blip than a change in a trend." Extreme and Juniper are exceptions; others will elect the merger path, he says.

After all, the valuations that acquirers are willing to pay for are getting pretty high, too. Geoff Yang, partner with the venture capital firm

Institutional Venture Partners

, estimates that the average dollar price for these deals has climbed 50% in the past six months. In March alone, the 80 employees of

Lightera

in Cupertino, Calif., sold to

Ciena

(CIEN) - Get Report

for $552 million in Ciena stock. Lightera will not have a product out of the lab until 2000.

"On a risk-reward basis," says Rachleff, "it's hard for many entrepreneurs to say no."