The announcement of the splitting of Orckit's activity into two separate companies, one for manufacturing ADSL chips, and the other for developing ADSL systems based on those chips, made no real impression on the capital market. Orckit's shares have fallen recently from over $90 to below $70.
Orckit apparently understands that, without the entrance of names like Cisco, Lucent, and 3Com, it is hard to gain the interest of the investing public, which doesn't really understand what it is investing in. This is apparently one of the reasons that Orckit is acquiring Silicon Value of Jerusalem for two million Orckit shares (about $140 million), and is negotiating to acquire two more Israeli companies. The two companies are EDSL, for $75 million, and Be-Connected of the Telrad group, for $120 million.
Before discussing the acquisitions (the one made and the two being negotiated), the positive upheaval recently undergone by Orckit should be mentioned. ADSL, in case you've forgotten, refers to communications systems enabling high-speed Internet transmission at up to 8 Mbps on regular telephone wires. What does this mean? It means exactly that, if you wanted to download the Encyclopedia Britannica from the Internet to your computer, you would need 16.6 minutes on an ADSL modem, compared to 3.2 days on a regular modem.
Back to the split. Why should Orckit separate its chip manufacturing, which has brought it universal appreciation? The chips, the brains of the ADSL systems, constitute a first class competitive tool, both in the past and at present. Within two to three years, however, the important field will be software, rather than hardware, and here is where Be-Connected comes into the picture.
The crucial factor is the rate at which technology is reducing costs. The cost of a call center line will reach $40, compared with the current cost of $500-600, which will make the field a commodity. This means that specializing players, who achieve economy of size and large market shares, will control the field. All these developments, together with the chance to build a $2 billion company "from scratch", are a good reason for splitting Orckit. In order to do this in the best way possible, Silicon Value has a role to play.
In order to understand what Orckit is paying $140 million for, you have to study what this company actually does, and why Clal Ventures and 3Com invested in it.
Silicon Value, founded in 1995, designs special ultra-high-density chips, which allow more chips to be inserted in any system. This is likely to reduce costs by 50%, improve the system's performance, and lower its power consumption by half or more. The company uses a faster, more sophisticated design process. It calls the final product ASiX, or Xtreme ASIC.
Why does this interest Orckit?
ADSL system prices under long-term contracts for telephony companies are already fixed at $300, so if costs can be lowered, Orckit's profits will rise. The way to reduce costs is to use Silicon Value's capabilities, and of course to sell to as many companies in the ADSL market as possible.
An added bonus is that Silicon Value, which posted 1999 sales of $5.5 million, compared with $3.5 million in 1998 (and is expected to enjoy significant growth in 2000), has an impressive list of customers, such as Lucent, Cisco, 3Com, and Microsoft's web-TV division. This means that the unified chip company, which will apparently retain the name Silicon Value, will enjoy both working relations with the best customers and a rich management team.
This, by the way, is also bad news for Viarta, which last week acquired Israeli company Inverness for $115 million and which can now expect to confront a powerful new factor in the market.
A few weeks ago, we spoke with a senior official in Orckit and discussed the potential of EDSL, a promising Israeli start-up, which we covered in November 1999. The official told us that, in his opinion, EDSL is competing in a niche market in the ADSL world, but after a ten-minute conversation, he changed his mind. "Actually, when I think about it, this is a giant market", he admitted.
We don't know if this is the reason, but Orckit is currently conducting intensive negotiations to acquire EDSL for $75 million in shares, "Globes" has learned. This is surely bringing broad grins to the faces of those at Discount Investments and the Genesis venture capital fund. Genesis invested $1.25 million in the company at the beginning of 1998, and in August 1999 Discount Investments invested $2.4 million and Genesis another $1.6 million at a company value of $8 million before money.
EDSL developed a high-speed communications systems for Internet-ready buildings based on local area network (LAN), which operates at the symmetric rate of 10 Mbps, 400 times the current speed of the Internet. EDSL's product is designed for conference calls, interactive multimedia applications, and the rest of the products offered us by the world of technology. Despite the short time the company has existed, it has already begun selling its products in recent months.
If Orckit does acquire EDSL, it will be able to offer this solution as a complement to the ADSL system.
We believe that demand in the hardware field will decrease in two to three years, and DSL companies' edge will be in the software field. That is the reason that Orckit is negotiating to acquire Be-Connected for $120 million. We note that the announcement of the negotiations was published in the press a few weeks ago, causing enormous damage to the negotiations and to trust between the parties. At the same time, it is estimated that Orckit is not ruling out the acquisition of a US company with similar activity; as far as is known, such contacts are taking place simultaneously to the negotiations with Be-Connected.
In software, the intention is to offer the customer a wide variety of capabilities. That is where Be-Connected can help. The Telrad subsidiary manufactures a multiplexing and access system for ADSL, called DSLAM. This system is designed to facilitate a variety of services, from telephony to broadband multimedia communications for the end user on one platform. It includes a flexible management system and is easy to install and maintain. Furthermore, the system has additional aspects of network planning and overload warnings, as well as the ability to implement rapid changes in the way the ADSL network works.
Published by Israel's Business Arena on March 27, 2000