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Climbing Back
Monday, April 1, 2002
“The growth of Cascade was an incredible experience,” says Dr. Hassan Ahmed, CEO of Sonus Networks. “You just don’t do that and end up building a multi-billion-dollar company and then go and do something that gets acquired in its early stages. I have zero interest in doing that.” But in these brutal times for networking product vendors, an acquisition back when times were good would probably have been a much less stressful option.

Ahmed was CTO of Cascade — the networking blockbuster founded by Sycamore Networks Chairman Desh Deshpande that was acquired by Ascend for $3.7 billion, and later became the core of Lucent’s networking product line.

In 1998, Ahmed left Ascend to join Sonus as CEO. The company, at the time an early stage startup, was looking to define the leading edge of packet-based voice services. As a networking product company tackling the core of the network with great technology, Sonus couldn’t have had better timing. The networking boom was just getting heated up, and the market frenzy that followed propelled the company to a lightning fast ramp-up and a successful IPO in 2000. Ahmed explains that Sonus consistently resisted the temptations to be “taken out” by an acquisition. The idea was to build a lasting company. Ahmed and his colleagues may not have been fully prepared for what would soon happen in the telecom sector.

The company did major core network deployments for hot-shot carriers like Global Grossing, Level 3, and XO Communications. But whereas the journey up couldn’t have been better scripted — the company was hoping to get its technology deployed and tested by aggressive early adopter carriers and it did just that — the crash proved unforgiving. The sudden reversal in fortunes for the new breed of early adopter carriers would hit Sonus (and many other networking product vendors) extremely hard. The stock went from a high of more than $80 to a low of just over $2.

Whereas customers like Global Crossing might have been predicted to struggle somewhat in the event of a capital crunch and waning investor confidence, they ended up with debt issues and financial difficulties that essentially wiped them from the list of potential customers for vendors hoping to sell cutting-edge networking gear. Ahmed admits that was “something that probably came as a bigger surprise.” Sonus was left managing the quarter-to-quarter expectations of a public company in a dismal market. Ahmed’s goal to build a company for the long haul suddenly seems a lot more challenging to fulfill.

A New Voice
Ahmed remains up beat. “We picked this market because there are vary few markets in the world that have the potential to generate lots of growth for a long period of time and this is clearly one of them,” he says.

Essentially, Sonus is in the business of developing voice networks on packet-based technology rather than on the circuit switched technology that is the staple of most current voice telephony networks.

Voice over IP has been a constantly talked-about phenomenon. Despite the hype, the fundamental drivers of the market remain.

“We’ve seen a very rapid decline in the cents per minute you pay for voice calling — particularly long distance calling,” Ahmed points out. “It turns out that voice is a price elastic service — meaning that as the price comes down people use it more so total revenues haven’t come down that much, but what has happened to carriers is that the margins that they can make have gotten thinner.”

The reason for this well-established reduction in margins is that fundamental cost structures haven’t come down, because circuit switched network technology is a relatively mature and old technology.

Packet based voice network technologies can introduce a new cost structure, and Ahmed claims that Sonus’ products can “put carriers on an aggressive cost curve right away.”

That said, the real value of voice over IP comes from carriers’ ability to easily add additional services to the voice service that they already provide and charge a premium for those services. Current phone bills have customers paying less for voice calls, but also paying for small fixed cost services, like voicemail, that greatly boost the carriers’ bottom line.

Sonus still competes most actively with incumbent providers of circuit switched technology — who still hold significant power of incumbency in the market. The company has won over established giants Qwest and BellSouth as customers. China Netcom just singed up for a full end-to-end voice over IP network deployment. And the company’s networks now carry two billion minutes of voice traffic a day.

But clearly, however good Sonus’ prospects are for the future, the current crunch in terms of capital spending from carriers will make things hard in the short term.

“Carrier spending is tied to much nearer-term returns than the greenfield spending you saw a couple of years ago,” Ahmed explains. He feels that his voice over packet technology can provide those rapid returns.

According to Morningstar analyst Jay Ritter, “While Sonus’ top line tripled last year, momentum has rapidly waned. December-quarter sales were flat sequentially, and with several carrier customers in financial distress, the March quarter is likely to be weak.”

Coming Out of It
But Ahmed remains positive about the future, and Sonus’ prospects in a recovery. “Today if you want to build a public packet network for delivering voice there’s really nobody else,” says Ahmed. But that could change.

“It seems fairly clear that the optical infrastructure is going to recover quite late in the game because so much of that has been built already. But when it comes to switching and routing and delivering services on optical pipes (the types of things we do) that part of the market will recover much faster,” Ahmed adds. That remains to be seen.

Sonus is as of now the early category leader in the voice over packet infrastructure market, and the best may yet be to come for the company. That said even Qwest has slashed spending, and sales cycles to the RBOCs and other established customers have been very much extended. As Sonus struggles to build up momentum again, many large competitors will likely start challenging for market share head on.

“The first time that we had to let people go was a watershed event. It was a loss of innocence if you will for a group that had really seen nothing but growth during the company’s lifetime,” Ahmed reflects. “The mistake a lot of companies make is that they throw their future overboard because they have to survive the present.” Ahmed does admit that laying off people was probably the hardest test so far.

Sonus is at a critical point in its history. Ahmed’s goal to build something really large and lasting depends on how the company can turn things around over the coming quarters. And, of course, how quickly carrier spending on voice networks improves.
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