Xtera IPO an Act of Desperation?

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Apparently, Xtera Communications’ desire to exit the optical business can no longer be characterized at all as graceful, but as somewhat frantic. There had been speculation in the industry that the supplier had even backed out on the idea of filing the S1, and then afterwards, it cut the terms of the IPO in half. There is no question that IPOs universally have been deferred lately as a result of market instability.

Although Xtera has truly compelling technology that amply differentiates itself from other vendors, the lack of a sexy story will not necessarily endear itself to investors. Also, they will probably be wary when it comes to its presently high level of customer concentration. However, if it is able to amply demonstrate a need for its technology by a number of the hyperscale data center players in the foreseeable future, then it may have a shot at attracting at least a limited amount of enthusiasm on Wall Street.

Xtera’s biggest weakness surrounds its decision a while ago to move from a submarine upgrade vendor to overstretching itself in becoming a full turnkey operator with all of its accompanying hard challenges, particularly the large amount of capital involved to create a successful business. Competitors, such as Huawei Marine Networks, Alcatel-Lucent Submarine Networks (although it remains to be seen whether there will be any negative effects resulting from the Nokia purchase as it was decided to keep the subsea business), TE Subcom, and NEC Submarine Systems, are all fully vertically integrated with ships, cable, repeaters, power equipment, and terminal gear. The lack of any of these piece-parts, such as in partnering with marine operations companies, results in higher costs because any entity that is supplying them to Xtera obviously requires a margin. (Although the supplier eventually started offering undersea repeaters in order to become more independent from external suppliers, getting them qualified as well as through all of the tests – and then having the ability to manufacture a sufficient number of them involves a large effort.)

At least in the past, given its limited experience on turnkey jobs, Xtera confined itself to those of a range of only 1,000 to 3,000 kilometers. Yet, these projects were still very ambitious for a comparatively small company, and the bigger suppliers have not been inclined to look at any undertaking as a giveaway because of the high margins that can be generated, along with their ability to get them done relatively quickly. Moreover, it was never clear whether Xtera’s decision was related totally to a marketing game plan or whether it was more about technical restrictions in finding a cable vendor that could support longer lengths.

As a result of the IPO, Xtera will certainly benefit in getting the word out more effectively on its technological advantages. At the same time, in no longer tending to be off the radar screen, it will now be forced to answer tough questions from the investment community regarding how it will effectively compete as by far the smallest equipment vendor in the long-haul space.

Perhaps, at least somewhat unconsciously, it is about Xtera’s management being so anxious to pull out of this currently miserable market by putting itself in a position to having to accept what it would otherwise perceive to be an insulting offer for its business, which is based on a public valuation of its assets.

[written by Mark Lutkowitz]