By Russ Mitchell

This article was originally published on SmartMoney Select on 8/22/02. NOT EVEN A PROMISING pedigree was enough to spare Agere Systems (NYSE:AGR.A – News) the indignities of the telecom meltdown.

Last week, the Lucent Technologies (NYSE:LU – News) spinoff unveiled plans to dump its optoelectronics business, close almost all of its manufacturing plants and lay off 4,000 — a third of its work force. The decision, though drastic, was all but unavoidable in light of the state of the industry and the health of the broader economy. What’s curious, though, has been the stock market’s reaction to it all.

Agere’s shares have been hovering between $1.50 and $1.70, off a 52-week high of $6.30. The price blipped up on the announcement, but only a tad. In other words, the market seems to be saying the news is practically neutral; that huge layoffs, plant shutdowns and a dramatic shift in strategy will leave the company worth about what it was worth before the announcement.

Clearly, that’s absurd. More likely, investors want to believe in Agere, but they don’t trust it yet. And who can blame them? Until early 2001, Agere was the microelectronics group at Lucent. Lucent spun it off because Lucent’s finances were in deep crud, just as AT&T (NYSE:T – News) spun off Lucent in 1996 because AT&T was in trouble.

Agere, for its part, came away with a potentially strong chip business and great technology — its roots go back to Bell Laboratories, and Agere is blessed with 6,000 patented technologies covering optics, integrated circuits and semiconductor manufacturing processes and technology.

But it also came away with horribly bloated operations. In the spring of 2001, Agere had 18,500 employees; by the end of next year that number should be down to 7,200. Lucent, in desperate straits, stuck Agere’s managers and shareholders with $2.5 billion in debt. Lucent also passed on a legacy of strategic mismanagement, which left the company saddled with semiconductor fabrication plants (known as fabs) that companies like Agere can no longer afford.

Credit Agere management for stripping the company down to its essentials. It’s closing all but one of its fabs, turning instead to contract fabrication outfits in Asia, as do most midsize and smaller chip companies. That means not only capital savings, but also savings of $100 million in annual process R&D costs. The optoelectronics business that it’s exiting — chiplike devices that route traffic on long-haul fiber-optic networks — may have brought Agere profits in the future, but it’s a business that may not recover for years. Agere can direct that investment elsewhere.

So where’s the focus going forward? Three chip markets, from fastest to slowest growing:

Wireless networks, including the fast-growing technology known as 802.11 (a.k.a. WiFi), and cellular telephones. Agere is a close No. 2 behind Intersil (NASDAQ:ISIL – News) in WiFi. Among its cell-phone customers is Samsung, which uses Agere chips in its new phones for 2.5G networks. Agere is also a major player in the flourishing cell-phone market in China.

High-density storage. Agere makes three chips essential to storage: One amplifies the signals picked up by the read head in the hard drive; another converts those amplified signals to digital; and a third controls the hard-drive motor. New chips combine the last two functions. Hard drives are commodities, but the chips that control them are not. Agere counts the four largest hard-drive manufacturers as major customers.

Multiservice network solutions. Marketing verbiage for chips that process data in networks. Customers here include Cisco (NASDAQ:CSCO – News), Riverstone (NASDAQ:RSTN – News) and Huawei, also known as the “Chinese Cisco.”

Clearly, Agere’s prospects depend on a capital-spending recovery. The company will lose money this year. But Greg Waters, senior vice president of strategy and business development at Agere, says the company is committed to paring costs to the point where it could break even on current revenues — about $500 million a quarter. “Even if the economy doesn’t improve, even if our business doesn’t improve, our cost structure will allow us to make money,” he says.

Not much money, of course, but Waters says that after breaking even, as much as 70% of new revenues could fall right down to the bottom line. In other words, when the economy turns around, Agere earnings will be positioned to take off, and midyear 2002 would prove to have been a great time to get into the stock.

Of course Agere, which is ranked as the No. 1 vendor of communications chips by Gartner, must execute — particularly with companies like Intel (NASDAQ:INTC – News) paying more attention to those very same communications chips. And Agere’s Lucent legacy gives cause for pause. But Waters, who came from Texas Instruments (NYSE:TXN – News) three years ago, says two-thirds of top management joined the company within the past two years. Another good sign.

Adding his two billion cents to the stock-options debate this week, Bill Gates said expensing options would have little negative effect on innovation.

In a recent column I argued that forcing young start-up companies to expense options would weigh down their net income, extend their periods of losses, make it harder for them to raise capital and, in the end, stifle innovation. I’m hardly the only one making that argument.

If Gates means that expensing options won’t slow innovation at huge, established companies such as Microsoft (NASDAQ:MSFT – News), he’s probably right. But if smaller, more innovative companies find it tougher to raise money, then it lowers the odds that new breakthrough technologies will emerge to challenge the giants…like Microsoft.

Russ Mitchell is a veteran technology journalist based in San Francisco.

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FOR RELEASE MONDAY JUNE 17, 2002

Transaction Expands Proxim’s Leadership Position in Wireless Networking Infrastructure Warburg Pincus and Broadview Capital to Invest in Proxim in Support of the Acquisition Sale Will Allow Agere To Sharpen Strategic Focus On 802.11/Wi-Fiâ„¢ Components SUNNYVALE, Calif. and ALLENTOWN, Pa. – June 17, 2002–Proxim Corporation (Nasdaq: PROX), a leading manufacturer of wireless networking equipment, and Agere Systems (NYSE: AGR.A, AGR.B), the world leader in communications components, today announced that Proxim has agreed to acquire the 802.11 wireless local area network (LAN) equipment business of Agere Systems, including its ORiNOCO product line, for $65 million in cash.

With the addition of ORiNOCO, Proxim will be the premier wireless equipment company with leadership positions in 802.11 enterprise LAN, public wireless access, distributed broadband and carrier-grade wireless backhaul systems markets. Under the agreement, Proxim will acquire assets primarily used by Agere in its wireless LAN equipment business, including a broad offering of wireless LAN products used in homes, small offices, enterprises, service providers and outdoor environments. Agere will retain its 802.11/Wi-Fi chips, modules, and cards business, representing the majority of Agere’s total Wi-Fi business. The sale will allow Agere to sharpen its focus on providing Wi-Fi component solutions for the emerging wireless computing, networking and entertainment markets.

“This transaction provides the scale, scope and depth that will allow us to continue our consolidation of the wireless infrastructure business, and to fulfill our vision of integrated wireless connectivity from the core network to devices in a home, office or public space,” said Jonathan Zakin, Proxim Corporation Chairman and Chief Executive Officer. “Upon closing of this transaction, we will provide investors with the broadest wireless pure play in the industry.”

The transaction enables the company to immediately realize revenues from the world’s largest installed user base of 802.11b infrastructure, which can in turn be upgraded to 802.11a technology over time. It also allows Proxim to accelerate revenues in the wireless WAN business by two quarters or more with a complete product line for the low-end bridging and last mile access markets. As a result, the company expects the transaction to be accretive in the first full operating quarter following the close. Agere and Proxim anticipate closing the transaction within 60 days, subject to regulatory approval and other customary closing conditions.

“In terms of positioning, customer base, technology portfolio and talent, this acquisition brings Proxim to the forefront of the wireless networking infrastructure businesses,” said David King, Proxim Corporation President and Chief Operating Officer. “With ORiNOCO, we obtain market leadership in 802.11b Wi-Fi enterprise network equipment, which complements Proxim’s leadership position in 802.11a WLAN solutions. In addition, ORiNOCO gives us a blue-chip strategic alliance portfolio as well as industry leadership in the growing WLAN public access “hot spot’ market.”

Agere and Proxim have also agreed to enter into a three-year strategic supply agreement under which Agere will provide chips, modules and cards to Proxim, a license agreement for Agere technology used in the ORiNOCO business and a broad patent cross-license agreement for their respective patent portfolios including settlement of the pending patent-related litigation between the two companies. Agere’s new strategic supply agreement with Proxim represents a new engagement with a leading wireless LAN equipment provider.

Agere developed key technology that led to the evolution of 802.11, and today is the leading provider of wireless data solutions to all of the world’s major PC makers. The company will continue to provide wireless data chips, modules and cards for this market segment. Going forward, Agere intends to deliver Wi-Fi components that will help reduce costs for customers so that they can deploy this technology in a wide range of high-volume computing, networking and entertainment markets.

“The sale will allow us to strengthen our relationships with key customers and sharpen our strategic focus on our core Wi-Fi chip business,” said Ron Black, executive vice president of Agere’s Client Systems Group. “Our Wi-Fi components are fundamental to meeting the growing demand for increased wireless data connectivity. Today’s action is a solid step forward in realizing our vision for ubiquitous, wireless broadband access at home, at work, and on the go.”

Warburg Pincus and Broadview Capital Partners To Invest in Proxim Warburg

Pincus and Broadview Capital Partners have agreed to collectively invest $75 million in Proxim to finance the acquisition. “We are excited about ProximÆs strategy to build the business and the impact the ORiNOCO acquisition will have upon accelerating the company’s roadmap,” said Larry Bettino, a Warburg Pincus Managing Director. “We support the vision of the Proxim management team and are firm believers in the compelling prospects of the wireless equipment market.”

The two investors will be issued convertible preferred stock in the amount of approximately $41 million, with a conversion price of $3.06 per share. The remaining $34 million of the investment will be in the form of a note that will convert, upon stockholder approval, into additional shares of the convertible preferred stock. Additionally, the investors will be granted warrants to acquire 12,271,345 shares of common stock for $3.06 per share. A portion of the warrants will be conditioned upon receipt of stockholder approval. Upon stockholder approval, the preferred stock and warrants issued to Warburg Pincus and Broadview are expected to represent approximately 28% of Proxim’s outstanding common stock on an as-converted and as-exercised basis.

Within three months of the closing of the transaction, Proxim plans to call a special stockholders’ meeting to approve the conversion of the convertible note and issuance of conditional warrants.

Proxim’s largest stockholder, affiliates of Ripplewood Holdings LLC, and Jonathan Zakin, Proxim’s Chairman and Chief Executive Officer, have agreed to vote their shares of common stock in favor of these proposals at the special stockholders’ meeting. They currently have the power to vote approximately 32% of Proxim’s outstanding common stock.

Broadview International LLC served as financial advisor to Proxim in its negotiations with Agere. Credit Suisse First Boston Corporation served as financial advisor to Proxim in its negotiations to secure the acquisition financing. JP Morgan served as financial advisor to Agere.

Conference Call/Webcast Information

Proxim Corporation and Agere Systems will each host teleconferences today to discuss the sale. Proxim’s teleconference will be available live and via replay through Proxim’s Web site at www.proxim.com. Agere’s teleconference will be available live and via replay through Agere’s Web site at www.agere.com. The minimum requirements to listen include sound capabilities on your personal computer and installation of RealPlayer software available at no cost for Windows 95/98, Windows 3.1, Windows NT, Macintosh, and UNIX systems from Real Audio, www.real.com.

Conference Call Information for Proxim Corporation

Today’s call begins at 8:30 am EDT/5:30 am PDT

Dial-In Information:

To listen to the conference call via telephone, dial 913-981-4910 at least five minutes prior to the scheduled start time.

Additionally, the conference call will be available on a recorded telephone archive by calling toll free 888-203-1112 and entering pass code 747653, beginning Monday, June 17, 2002 at Noon, EDT until 8:00 PM EDT on Thursday, June 20, 2002. For international callers, the recorded telephone archive is available by calling the following toll number: 719-457-0820 and entering pass code 747653.

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