Tellabs Downgraded to Underperform

We downgrade our recommendation for Tellabs Inc. (TLAB) to Underperform, following its weak financial results for the fourth quarter of 2010, well below the Zacks Consensus Estimates. Tellabs is facing serious problems in its core wireless backhaul solutions segment.

AT&T (T) was its major customer for its 8800 multi-service router. Recently, AT&T decided to upgrade its network with pure Ethernet solutions since the company is moving towards deploying 4G LTE networks.

As a result, the company is now using low-cost Ethernet routers of Cisco Systems Inc. (CSCO) and Alcatel-Lucent (ALU) instead of Tellabs. During 2010, AT&T helped generate 35% of total sales of Tellabs and 40% of Data product revenue. We believe loss of businesses from AT&T will have severe consequences on Tellabs’ financials in 2011.

In the fourth quarter of 2010, Tellabs suffered revenue setback with respect to two of its high-margin products. In addition to 8800 series managed-edge multi-service router, the company also generated lower revenue from its 5500 series digital cross-connect products.

Sequential sales decline was 40% for this product. As a result, gross margin in the fourth quarter of 2010 was 42% compared to 45.3% in the year-ago quarter.

Tellabs has given a weak financial outlook for the first quarter of 2011. Revenue guidance was below the consensus estimates and gross margin guidance is a poor 40%, a significant fall from 50.7% in the prior-year quarter.

Total revenue is expected to decline by around 15% year over year. This indicates, besides the continuous decline of sales of Tellabs’ legacy products, its newly launched growth products may start facing stiff competition.

Tellabs has decided to expand globally. Although international revenue is grossly offsetting the loss of revenue in North America, Tellabs is facing margin pressure. The company is forced to sell its growth products at lower margin in these regions to capture market share.

TELLABS INC (TLAB): Free Stock Analysis Report

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