Acquisitions Adtran Should Consider - Calix And Clearfield

Includes: ADTN, CALX, CLFD
by: FTTH investment guru

In the world of Tier 2 and Tier 3 telecommunications carriers, government funding programs can have a dramatic effect on spending plans for capital and network infrastructure. In 2009, when President Obama's first broadband stimulus plan was announced, these Tier 2 and Tier 3 carriers had to reevaluate their current projects and to analyze whether or not they should participate in the program. Most of that broadband stimulus money has not even been spent yet due to 1) the lengthy approval and distribution process, 2) environmental studies, and 3) the fiber shortage caused by last year's tsunami in Japan. Now, the Universal Service Fund/Inter-Carrier Compensation reform and Connect America Fund implementation announced last fall is readdressing how Tier 3 carriers obtain operating subsidies from the government but is also granting large sums for capital projects. This is causing carriers to not only evaluate if they should apply for funding, but also rework their entire business model. In fact, it could result in some carriers not continuing as a standalone entities. This evaluation period has caused many projects to be put on hold and the impact is evident in the latest earning reports of Adtran, Calix, and Clearfield.

Calix (NYSE:CALX) reported flat revenues last quarter and alluded to more of the same throughout 2012. Clearfield seems to be weathering the storm better than both Adtran and Calix. Clearfield (NASDAQ:CLFD) actually reported record revenues up 50% over last quarter and posted double digit gains compared to last year in its first three fiscal quarters of 2012. Clearfield has a more diversified product portfolio and seems to be offsetting the Tier 3 carrier stagnant spending with sales to cable operators and for cell back haul projects. Regardless, its stock price cannot seem to get any traction due to the Connect American Fund effect and the drag it is having on the sector. Both companies are looking for the Tier 3 carriers to rebound in 2013 as the evaluation period ends and more clarity on the program is issued.

So why these two companies? Calix, a direct competitor to Adtran (NASDAQ:ADTN), furthered its Tier 3 presence with the purchase of Occam Networks last year (it should be noted that Calix today is trading $50m less than what it paid for Occam Networks) and will likely eat away at Adtran's market share in marquee Tier 2 carrier accounts. Calix has already begun receiving orders from Frontier for the 4M lines spun off by Verizon, where Adtran is the primary supplier (a position held by Calix at CenturyLink). Calix is also finalizing key certifications in 4TH Q2012 at CenturyLink's Qwest properties that will open up additional revenue opportunities. Buying Calix on the cheap would create a dominant force in the space that should allow for pricing strength vs. a potential price war or market erosion down the road. Pricing strength, when your customer base is flush with government cash, is an enviable position to be in. Adtran should be able to materially grow margins in this scenario. Between the Connect America Fund and the still unspent stimulus dollars, there are large revenue opportunities in 2013 and beyond.

A Calix/Adtran merger would have over-laps in development, sales and marketing, and would eliminate millions in the duplicate G&A expenses of being a public company. It should be easy for Adtran to make the acquisition of Calix immediately accretive to earnings EVEN IF it paid a considerable premium to the current market price of Calix. Adtran can afford acquisitions; as of June it had 555M in cash and only 46.5M of long-term debt.

Clearfield, while certainly smaller in size, would deepen Adtran's product portfolio as it provides fiber management systems. It builds highly customized, modular solutions, with rapid turns (fulfillment) in 6 days. Clearfield's solutions would be an excellent compliment to Adtran's TA5000 mobile back haul solution. Clearfield is profitable and continues to make investments in new products and is starting to market its products internationally. I believe that if Adtran stuffed Clearfield's product-set down their sales channel, they could see considerably more market penetration, with faster speed than Clearfield can on their own. This would be a deep revenue synergy for Adtran versus a Calix acquisition, which would likely be more of an operating synergy, and at a much lower cost and risk.

What would be the motivation for Calix and Clearfield to sell? For Calix, you likely have a very dissatisfied investor base. The stock is 65% off its IPO price and 80% off its high of last year. I assume a good portion of the long term investors likely cashed out during the IPO or during the run into the low 20s. Calix poached Occam Networks (much to the dismay of some of Occam's largest shareholders as the lawsuit against Occam's board is still pending) and what's good for the goose, could be good for the gander. I would not be surprised if some board members and major investors would not warm to a reasonable offer. For Clearfield, the company is profitable so the urgency probably is not that great. But considering upcoming capital gains changes and the fact that Clearfield's major shareholder and management have shares and options are in the money, the timing might be right if they can close before end of 2012. Considering its microcap size, nonexistent position in the analyst community, it continues to fly way under the radar. In my opinion, it is only a matter of when, not if, that Clearfield becomes part of a larger organization. Adtran is one of 3 to 4 suitors that make perfect sense, especially at more reasonable valuation levels compared to last year.

Disclosure: I am long CLFD.