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Getting back its brilliance

twitter-logoGoutam Das | Print Edition: April 14, 2013

On December 30, 2011, Cyclone Thane hit the Tamil Nadu coast with winds of 140 km per hour and tidal surges of 1.5 metres. The hurricane blew the roof off Tejas Networks's factory in Puducherry, which makes telecom networking gear. The flooded factory stopped work, resulting in a two-week disruption of the supply chain.

Just two months later, in February 2012, a fire that started elsewhere in Tejas's office building on Bangalore's Hosur Road engulfed the company's sixth floor lab. The smoke and soot damaged equipment, halting work for a week.

The calamities only added to the networking products company's poor run.

"We had fire, floods and scams," says co-founder and CEO of Tejas Networks Sanjay Nayak with a laugh. It was much less funny when the 3G auction in 2010 and the 2G spectrum scam in 2011 made telecom operators wary of spending on equipment. According to market research company Ovum, in 2009, Indian vendor revenues in the networking equipment market that Tejas plays in were $844 million (around Rs 4,587 crore).

In the four quarters up to September 2012, this had dropped 49 per cent to $430 million, while capital expenditure in telecom fell 48 per cent during the same period. After seven years of rapid growth, the company peaked at Rs 706 crore in 2008/09, but revenues nosedived 70 per cent to Rs 213 crore in 2011/12. After being profitable for years, the company slipped into the red.

Many question whether the company is headed in the same direction as Sycamore Networks, the former stock market darling that in March 2000 was worth $45 billion in the United States. On January 29 this year, Sycamore shareholders voted to dissolve the company, whose worth had declined to $64 million. The company failed to keep up with growing competition and commoditisation of the networking marketplace.

Sycamore's co-founder, Indian-American entrepreneur and venture capitalist Gururaj "Desh" Deshpande, has invested $30 million in Tejas and is its Chairman. Tejas, founded in 2000 by Nayak, Kumar N. Sivarajan (who is Chief Technology Officer) and Arnob Roy (President, Engineering), began by reselling Sycamore products in India and went on to make gear.

Both Sycamore and Tejas make and sell optical networking equipment, which uses pulses of light to transmit voice, data and video. With data downloads becoming more common in India, telecom companies are expected to switch from microwave transmission to optical networking wherever possible, as it is far more efficient. A single wavelength of light can carry hundreds of gigabits of data, compared with 300 megabits on microwave networks.

Gururaj Deshpande
In 2000, a lot of VCs in the US said companies would have CEOs in California and the team in India, and they said they would go after the Indian market. That does not work: Gururaj Deshpande
While Sycamore's failure has made people sceptical about Tejas, Deshpande argues Tejas can swim again and take on the Chinese, particularly Huawei. Tejas has different DNA, he says, and is more cost-competitive and innovative.

"The magic of Sycamore was its technology - people could get huge amount of bandwidth," says Deshpande, who spoke to Business Today on the phone from the US. "When we had a huge market cap of $40-50 billion, every venture guy wanted a Sycamore-like company. There were about 250 Sycamore Networks." He points out that big companies such as Alcatel and Nortel invested huge amounts of R&D in the same optical technology.

He explains what went wrong: "Then suddenly, the industry found that the capability of the technology was huge - 200 laser beams on a fibre and people could barely use five or six. The technology overshot big way in terms of what it was capable of doing and what was needed. When that happens, it becomes a commodity market. That's not Sycamore's strength."

Tejas is a different story, says Deshpande, as it's not trying to sell high-end technology like Sycamore. It was more of a business plan innovation, he adds, to sell optical gear using India's low-cost resources. CEO Nayak adds that Tejas is also innovative in other ways - for instance, in how it develops products.

Traditional networking companies spent a lot of time designing a custom chip for a networking product, which was relatively expensive, but Tejas planted Field-Programmable Gate Arrays (FPGA) - programmable integrated circuits - inside its products.

Nayak says: "FPGA can be bought off the shelf. You can program most of the networking functionality and create a hardware which is flexible and resilient. It has a shorter product development cycle than anybody in the world today."

Since 2004, Tejas has won innovation and excellence awards almost every year. Twice it has won the Diamond Jubilee Technology Award - regarded as India's highest technology prize - of the Council of Scientific and Industrial Research.

Customers like Tejas because it is cost competitive and innovative. Tata Communications is one of its oldest customers. New Jersey-based Matthew Ma, Vice President of Transport Network Engineering at the Tata company says his firm picked Tejas because of its low-cost and feature-rich products, its understanding of the Indian market and its customer-friendliness.

In optical networking, Tata Communications has other vendors, such as Ciena, Alcatel-Lucent, Huawei and ECI Telecom. "We have lot of platforms in our network. For the same purpose, we typically have two or three vendors. Tejas is deployed in our metro (networking for a metropolitan area). Here, they are definitely ranked top one or two among other vendors," Ma says.

Even with its revenues shrinking, Tejas has a good market share in optical networking in India. According to research firm Ovum, its share increased from 13 per cent in the first quarter of 2009 to 23 per cent in the third quarter of 2012. It is ahead of Huawei (19 per cent) and ECI (15 per cent). Tejas's customers have loosened their purse strings a bit in 2012/13, and the company has grown 50 per cent from the low of the previous year.

But to get out of the woods, the company needs to sustain the momentum - easier said than done in a cyclical market. When Tejas peaked at Rs 706 crore in 2008/09, it was because of two big Bharat Sanchar Nigam Ltd (BSNL) tenders. BSNL did not make many purchases in the following years.

Sanjay Nayak
CEO Sanjay Nayak says Tejas's business model will increase its international revenue mix Photo: Deepak G . Pawar
The domestic market for Tejas may grow over the next two or three years, in large part due to increasing government spending. Tejas may benefit from an October 2012 draft policy notification that says the government will give preference to telecom equipment made in India, due to security concerns.

Besides, Tejas has also started to make a big push outside the country. It sells directly under the Tejas brand in Bangladesh, Mexico, and several African and South East Asian countries. In western markets, where marketing is expensive, the company plans to take on Chinese competition by tying up with Western and Japanese companies who would white-label its gear.

"Chinese companies have the same DNA as Indian companies," says Nayak. "When the price got set by the Chinese, the financials of western networking companies deteriorated." He says today, the entire telecommunications and network industry operates at 40 per cent gross margins. He adds: "But the sales, general and administrative expenses and R&D of all western companies is around 40 per cent. Therefore, you are not making any money...the cost structure is very high while the selling price is low. This is the opportunity we saw."

In 2012, for instance, Parisbased Alcatel-Lucent reported a net loss of i1.4 billion (Rs 9,852 crore). The company is tight-lipped but sources say Tejas has signed OEM deals with US-based optical networking company Ciena (net loss of $144 million in 2012) and with a large Japanese telecommunication company.

Nayak calls this business model a "game changer". He says: "While R&D is our strength for selling telecom products to the world, we are not there as a country." The model would let western companies have access to cheaper products and compete better with Chinese vendors. And it would help Tejas increase its international revenue mix to 40 to 45 per cent of overall revenues in 2012/13, from 25 per cent last year, says Nayak.

However, investors are unlikely to forget the Sycamore hangover in a hurry (see Who Invested, Who Sold). The Sun Group, Battery Ventures and IL&FS have exited, and more may do so. Given its strategy to counter Chinese competition, doesn't it make sense for a western networking company to acquire Tejas?

"Maybe, maybe not," says Deshpande. "I think western companies should be a little careful. In 2000, many venture capitalists in the US said it was a great model - companies would have CEOs in California and the team in India. They said they would go after the Indian market. That doesn't work. If you want a 15 to 20 per cent bottom line on a 40 to 45 per cent margin, you need a team in India which can drive with their cost models."

Nayak may well have been advised by the board not to get distracted by talk of acquisition, an IPO or any other form of fundraising. Sustained growth alone can calm investors' nerves.

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