New Parent Prods Xylan To Reset Government Goals

By Richard McCaffery, Staff WriterAlcatel's proposed $2 billion acquisition of Xylan Corp. gives the networking company new punch in the federal market as it tries to expand, increase support services and compete with giants like Cisco, Lucent and 3Com, company officials said.Xylan of Calabasas, Calif., which has a federal office in Rockville, Md., plans to use Alcatel's bulk first to grow its networking business with the Air Force, NASA and the Energy Department, said Brett Michaels, Xylan's vice president of federal sales. "They have the finances and worldwide support infrastructure to guarantee to the government we can take on any project," Michaels said.Just compare Xylan's 950 employees and $1.5 billion market value to Paris-based Alcatel's work force of nearly 200,000 and market cap of $21 billion.Xylan already is resetting its government goals. The company's federal division, which had $43 million in sales last year and expected to double it in 1999, is now pushing for a bit more, said Michaels. "We see tremendous opportunity because of the size of Alcatel and the strength they bring to market," he said. No specific revenue goal has been set."Xylan is a key part of Alcatel's plan to meet a variety of customer needs for next generation networks," said Amy Morenz, Alcatel's press officer. In fact, Alcatel has formed a new Internet division aimed at leading the company's network strategy, Morenz said. The division will be headed by Martin de Prycker, formerly director of Alcatel's network strategy. Details such as where the division will be based or how Xylan fits into it have not been finalized.Co-founded in 1993 by Steve Kim, now chairman and chief executive, and three partners, Xylan makes data networking switches. These devices act like traffic lights on the information highway, sending data such as e-mail to the right places. When Kim started the company, he bet switches would soon replace routers as the most efficient means of directing traffic in local area networks because they are faster and less expensive. His gamble paid off. The Xylan acquisition, which was announced March 2 and is expected to close in April, is part of a trend driving telecommunications and networking companies together. Customers no longer want separate lines for telephones and data networks. Instead video, voice and data links are converging, and companies like Cisco Systems Inc. of San Jose, Calif., and Lucent Technologies Inc. of Murray Hill, N.J., are bulking up to capture market share.In January, Lucent announced plans to buy Ascend Communications Inc. for $20 billion. In August, Northern Telecom Ltd. bought Bay Networks Inc. for $9.1 billion. Cisco has bought more than 25 companies since 1993. And two days after Alcatel announced it was buying Xylan, it signed an agreement to buy Assured Access Technology Inc. of Milpitas, Calif., for $350 million. Assured makes networking products used to send voice and data over the Internet."Everybody has to figure out how they're going to compete against Cisco and Lucent," said James Wade, an equity analyst at BT Alex. Brown Inc. in Baltimore. "In that world, size matters." Though Xylan grew fast — revenue zipped from $443,000 in 1994 to $348 million in 1998 — it always has been a small fish in a big pond. Consider market leader Cisco, which posted sales of $8.5 billion last year and has a market value of $155 billion.Xylan has more than 4,000 commercial and government customers, including Alcatel, IBM Corp. of Armonk, N.Y., the Navy and the Army. Government revenues are 12 percent of total sales.For the last two years, Xylan has grown 65 percent annually, outpacing the data networking market, company officials said. The market for networking switches has grown from $83 million in 1993 to a projected $7.9 billion last year, according to the Dell'Oro Group, a Portola Valley, Calif., consulting company. Despite its growth, Xylan needed a partner to compete in today's consolidating market, company officials said. "It became clear that, to be a major player, we'd need to be part of a larger company, someone that's a leader in the voice industry," said Douglas Hill, Xylan's vice president of corporate marketing.Analysts agreed. "They've done an outstanding job competing against Cisco. But as the stakes get a little higher, the issues get a little bigger," said Paul Johnson, an analyst at BankBoston Robertson Stephens in Boston.Strong performance has not kept the stock from being shaky. In 1996, Xylan issued stock in a follow-on offering at $54 a share. Last year, shares hit a low of $9.62.Analysts say several factors have hurt Xylan's stock price. First, Xylan is a technology company with a small capitalization in a volatile market, said Wade of BT Alex. Brown. The lagging share price also can be attributed to competing with and being compared to market leader Cisco, as well as occasionally missing analysts' expectations.But the acquisition will yield a nice payday for investors. Xylan was trading around $20 a share before Alcatel came and offered to pay $37 each for all outstanding shares, a premium nearly twice Xylan's market value at the time. The stock quickly jumped to $36 a share. Alcatel owned nearly 7 percent of Xylan's stock before the acquisition.Under the deal, Xylan will keep its brand name and function as a wholly owned subsidiary. No layoffs are expected, and Kim will continue as chairman and chief executive, said Hill. So far, the only changes are Xylan's revenue goals. Alcatel expects Xylan to be a $1 billion company by 2001, Hill said.