In a way, Zhone (NASDAQ:ZHNE) is the result of an interesting financial experiment. In late 1999, a group of private equity firms -- Texas-Pacific Group and Kohlberg Kravis Roberts & Co. -- decided to enter the fast-growing telecom game. At that time, the leverage-buyout game was too Old Economy. With all its cash, major private equity funds saw the New Economy as a way to make a quick buck.
In the Zhone deal, the private equity firms teamed up with CS First Boston and New Enterprise Associates, a venture capital firm, to pony up $500 million for Zhone. Interestingly enough, Zhone was a start-up, but one with a sterling list of executives. The business plan called for rolling up the lucrative telecom equipment marketplace.
Well, these investors actually entered the twilight Zhone. Of course, it was the top of a frothy market.
Despite the telecom meltdown, Zhone did not abandon its mission as an acquisition vehicle. In 2003, the company did a reverse merger, allowing it to become a public company-and make even more deals.
Zhone's latest deal is the purchase of Paradyne Networks Inc. (NASDAQ:PDYN) for $180 million. Yes, the deal is in the form of stock and represents a big portion of Zhone, which has a market cap of $288 million. On the news, the stock price of Paradyne surged over 50%.
Unfortunately, Zhone's stock performance was much different--it plunged almost 19%. Then again, the conference call was somewhat vague. It sounded like the typical stuff of a muddled deal: cost savings (probably in the form of headcount reductions), expanded customer base, more product offerings, and an improved balance sheet.
Why an improved balance sheet? Well, Zhone has negative cash flows. As for Paradyne, it has $42.2 million in cash. This is an easy way for Zhone to feed the beast.
But investors should be wary of Zhone's optimism on the deal. Keep in mind that the company has spent $850 million on 12 acquisitions over the past six years. Still, the company generated a mere $27.6 million in revenues last quarter, and the net loss was $5.1 million.
Be that as it may, there is a bright spot. Upon announcement of the deal, Zhone also indicated that it will have slightly better results for the second quarter. This is also the case with Paradyne. What's more, it appears that there may be a pickup in telecom purchases, as the carriers have put off spending for awhile.
And there are also new investments in things like VOIP. But in the world of telecom equipment providers--with large companies like Nortel (NYSE:NT) and Lucent (NYSE:LU)--the company will probably need to do more deals to get critical mass. Or maybe just sell out to do so.
Fool contributor Tom Taulli does not own shares of any of the companies mentioned in this article. The Motley Fool has an ironclad disclosure policy.
