Ever wonder how your wireless phone call gets to cousin Eddie's landline in Tulsa? Or how your cable company is able to offer local phone service over its coaxial cable network? What about how that email you sent works its way over a copper wire from your house, is then translated into light beams and sent over a long-haul fiber optic line, and ends up in the email inbox of 15 different friends in 15 different cities with employers that use different networks based on a combination of Internet protocol (IP), asynchronous transfer mode (ATM), and frame relay.
Huh? Don't worry, Tellabs (Nasdaq: TLAB) knows.
Tellabs makes the devices to handle these situations. It's the organizer and interpreter of the new economy, or, more accurately, it makes the equipment that organizes and interprets the many languages of the digital world. Whether it's voice, data, or video traffic, over copper or fiber, Tellabs' boxes can help. And when a company is so bold as to say, "Most telephone calls and Internet sessions in the United States now flow through [Tellabs'] equipment," we take notice at Fool Central.
This mild-mannered Lisle, Ill.-based maker of telecommunications equipment has kept a low profile with regard to its better-known competitors such as Alcatel (NYSE: ALA), Ciena (Nasdaq: CIEN), Cisco (Nasdaq: CSCO), and Lucent (NYSE: LU). But with $3.5 billion in revenue and net margins north of 20%, the time has come to test this baby on the Maker track. Over the next few articles, I'll dig into the qualitative and quantitative side of Tellabs. This week, we look at its current and future revenue streams.
The digital world is getting... what? Simpler or more complex? That's right -- more complex. There are more transport options for digital traffic and more devices linked together than ever before. No matter what happens to the Nasdaq over the next week, month, or year, things will get even more digital. Tellabs profits from this information chaos by making devices that help information move from network to network, architecture to architecture, and device to device. If the Internet were a VCR, Tellabs would have no problem programming it.
Tellabs' primary customers are the Baby Bells -- such as Verizon (NYSE: VZ) and SBC Communications (NYSE: SBC) -- which account for a third of its revenue. Tellabs breaks its product lines into three technologies: optical networking, voice-quality enhancement, and broadband access -- all of which are growing at very healthy rates despite the current slowdown. As recently as March 7, management reaffirmed guidance for 30% to 35% year-over-year growth.
Growth is coming from several areas. According to Tellabs' 2000 annual report (.pdf), the pure optical segment is expected to grow from $800 million today to $6 billion by 2003. Broadband access is anticipated to grow from $900 million today to $7 billion by 2003. Sounds like expanding possibilities to me.
Tellabs' arsenal of products has grown thanks, in part, to several key acquisitions over the past few years. A $575 million purchase of NetCore Systems in 1999 accelerated Tellabs' entry into high-speed router solutions. Its purchase of the European unit of DSC Communications from French telecom giant Alcatel jump-started its international presence and added managed, high-speed transport systems based on synchronous digital hierarchy (SDH) and dense wavelength division multiplexing (DWDM) technology. The acquisition of SALIX Technologies allowed Tellabs to enter the exciting voice over Internet protocol (VoIP) market. Finally, its most recent deal for Future Networks enables Tellabs to offer an end-to-end, multi-services (i.e., telephony, Internet connectivity, and cable TV) solution to cable operators.
But for now and the foreseeable future, Tellabs' largest revenue driver is the TITAN series. The TITAN digital cross-connect systems are used to direct different protocols such as Internet protocol (IP), asynchronous transfer mode (ATM), and eventually voice. The TITAN system receives the signals coming into a central office (CO), separates and sorts them according to their final destination, determines the best route to that destination, bundles calls bound for the same destinations, and sends them on their way. Sales of the TITAN 5500 were up 56% in 2000, the third straight year of accelerating revenue growth.
Tellabs also has a line of echo cancellers and other integrated voice-enhancement technologies under the VERITY brand. These devices do just what they sound like they should do: They improve voice and sound quality of transmissions. As more and more voice traffic moves onto data networks -- from a circuit-based network to a packet-based network -- these devices are moving up the IT food chain.
See, most telephone calls are placed over circuit-switched networks that assign a fixed amount of capacity to each call and require a constant path or circuit for the duration of the call. This method ties up the line until one of the parties hangs up. The future is in networks that break up the call into chunks of bits called packets because they use network capacity much more efficiently. Packet-based systems eliminate "dead air" by removing the silences and compressing data.
IP telephony allows companies to send voice, video, and data over the same infrastructure, thereby allowing cost savings from an equipment and connectivity perspective. Most of the big names in telecommunications are also eyeing this market.
Tellabs also makes CABLESPAN systems that offer integrated voice and data services over cable TV networks. It also has a line of managed access and transport network systems that handle wired and wireless communications.
Less than 1% of Tellabs' $3.4 billion in 2000 revenue came from new products and only 22% of sales were generated outside the U.S., so management is shaking things up at the suburban Chicago headquarters. Last year, Tellabs introduced five new products. This year, it plans to expand its international marketing and is adding a line of products designed to meet both North American and world standards.
Not long ago, Tellabs was excluded from the next-generation reindeer games. Its products were considered yesterday's news because they were aligned with the old fuddy-duddy telephone network instead of the next-generation data network. Today, those relatively stable revenue streams and long-standing relationships with local exchange carriers are smoothing Tellabs' transition through the convergence of voice, video, and data networks.
Next week -- the numbers. Here's a little taste. Revenues have grown at a 38% average annual growth rate over the last five years, but at $43 per share, Tellabs is richly priced at 82x trailing free cash flow.
Todd Lebor does not own shares in Tellabs but did sleep in a Holiday Inn Express last night. Todd owns shares of Cisco and SBC Communications. His other devalued holdings can be found in his profile. The Motley Fool is investors writing for investors.