Kiss and Tellabs

02/11/2008 12:00 am EST

Focus:

George Putnam

Editor, The Turnaround Letter

George Putnam, editor of the Turnaround Letter, says the telecom equipment maker should profit from a big upswing in spending by its customers—and takeover speculation.

Tellabs’ roots go back to 1975 when the company used echosuppression technology to improve voice transmissions. The company broadened its product line and became known as an innovative producer of telecommunications equipment for a wide range of wireline and wireless applications.

Tellabs (NASDAQ: TLAB) rode the telecom spending wave of the 1990s, and its stock climbed as high as $77 in 1999. But when many of its customers failed in 2001 and 2002, Tellabs’ revenues, profits and stock price all came crashing down. From a high of $3.3 billion in 1999, revenues fell below $1.0 billion in 2003, and the stock traded below $5.

Unlike many of its customers, Tellabs was a survivor. It cut costs and rebuilt its sales.
The stock price climbed back to $17 by the spring of 2006. Unfortunately, the company then suffered as its [large] customers consolidated, and it was slow to bring out some new products.

[Now] Tellabs appears to be getting back on track. It has gotten the next generation of products out into the marketplace, although it will take a while for them to be fully accepted by its customers. But Tellabs has strong relations with many of the key equipment purchasers in North America, as well as a great reputation for innovative products, and so it should not take too long for sales to rebound.

In the meantime, Tellabs is in the midst of a program to reduce expenses by $100 million. All of the telecommunications providers, both land-based and wireless, are being forced to upgrade their equipment to offer new services such as video and to keep up with increases in volumes of data.

While the telephone companies have been moving cautiously in boosting their capital expenditures, we expect the pace to pick up as competitive pressures increase. Tellabs is well-positioned to benefit from this increased capital spending.

Tellabs’ strong reputation and good customer base [also] would make it an attractive acquisition candidate. With its strength in the North American market, coupled with the weak US dollar, Tellabs could be particularly attractive to a foreign buyer. In fact, Tellabs reportedly rebuffed a $16-per-share offer from Nokia last summer. The stock price has declined since then, and so management might be more receptive to a new offer.

Another attractive feature of Tellabs is its balance sheet. It has essentially no debt and $1.5 billion ($3.00 per share) in cash and marketable securities. The company is currently using some of that cash to buy back shares. We believe Tellabs is well positioned to benefit as expenditures on telecom equipment grow. Also, it could be snapped up by a larger competitor. Either way, shareholders will fare well, and we recommend buying Tellabs up to $10. (It closed below $7.00 Friday—Editor.)

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