Chapter 14 - Internetworking: Emergence 1985-1988
The perception, and even understanding, that IP routing represented a new and potentially significant new market was not lost on some engineers and managers within existing firms. An excellent case is that of Ungermann-Bass (UB) where the initiative of John Davidson and others led to an early implementation of a router but the concept was “killed” in the corporate planning process. The example of UB undoubtedly reflects the company’s efforts to reduce its product development and marketing expenses given the difficult financial year management was expecting: in 1986, UB’s Net Income totaled only $18 thousand on sales of $110.9 million. Nevertheless, one choice played a big role in UB’s participation in the Internetworking market. Davidson laments:
In 1986, it became apparent that we could do something with our 68K-based bridging product and software to turn it into a router. And I had my group of people create an IP router in 1986, and not just for purposes of show. I decided “We’re going to go get some business with this router, and then we’re going to bring it to one of these crazy planning meetings we have and I’m going to say: ‘By the way, we’ve already done it.” So we actually got a customer to work with out sales office out of Philadelphia and our technical support people and deploy six boxes, which were standard manufacturing release boxes, at the ends of three different T1 links to connect their six networks together, using these boxes for IP routing. And we built some special management software for them on a PC platform, and did everything the customer asked us to do, and we won that business. We displaced Proteon, we displaced Cisco, and the customer said: “We like this router. We’ll work with you guys. We like working with you, we like the management stuff you’ve got, plus you’ve got all these other things. Dynamite.” I brought that product and that result to a planning meeting in 1986, and maybe representative of our problems at that point; it was rejected flat out as not what the customers wanted. ‘Customers want bridges, not routers,’ and they asked us to stop working on it.
A bigger choice, one demanding an executive decision with serious consequences, was what to do about the INI division and the financial relationship with General Electric. Making the decision even more difficult, INI was Ralph Ungermann, the CEO’s idea. Ungermann recalls the criticism he took for the company’s strategy and reveals an understandable bitterness regarding the failed MAP –GE decision:
It’s actually a very simple strategy, and it was highly criticized, but every single company that’s not a computer company has adopted it behind us. So, it was highly criticized, but widely accepted. The idea was that if you want to buy a system from IBM, it’s going to be Token Ring. If you want to buy a system from DEC, it’s going to be Ethernet. If you want to buy a system from both of them, it’s going to be Ethernet and Token Ring, ergo, a business opportunity, a niche. A broad product offering is required to support that niche, so you’re not in business unless you’ve got a product line. So everybody said: “Ungermann-Bass is unfocused. They’re doing too many things,” but today, Bridge does Token Ring and broadband and Ethernet, and in fact, mastering those technologies is not very tough. Well, that’s not true. Token Ring investment was an enormous investment, and broadband technology was a big investment, but they’re do-able. They’re engineering feats that, if you’ve got good engineering organizations, you can really do.
The thing that got Ungermann-Bass in trouble was we poured all of our money into that factory networking business unit, and all of our resources into that, and all of a sudden somebody decided that the technology that we were delivering – and we had 70% market share – was going to be made obsolete by a new standard, and that maybe it is our fault for not driving that standard more, but we didn’t, and it happened, and all of a sudden we had an obsolete business unit with a huge portion of our resources going into it, and we had to shift from that. We had to shut that down, meld it back into the organization, and change a lot of people’s careers and direction, and everything else.
So it was an enormous dislocation for this company, but we take risks and we missed one. So what? You keep going. We took a gamble on broadband, made a go. We made a gamble on being able to provide an IBM compatible Token Ring, and we’re doing that, and we picked MAP, and we missed. So we picked three out of four, and that hurts, but so what? We’re going to keep going. We’re the only company that can come in today and provide you with a very broad connectivity of IBM and DEC, all based on open standards, and today I think everybody recognizes that’s the only winning strategy for an independent LAN company. So everybody has adopted that strategy.
The need to cut losses and curtail the painful drain on capital forced a restructuring of the relationship with GE. After protracted discussions, in October 1987, UB announced that GE would exchange its 36 percent interest in INI for a 3.6% interest in UB with a four-year option to buy another 3.6% of UB’s stock. INI was soon “melded in,” ending the days of big spending on MAP.
Even though 1987 was shaping up to be a good year, certainly much better than it could have been given 1986, there was no way management could have anticipated the market crash of October 1987. With its share price driven down from nearly $12.00 per share to just over $7.00 per share, investors jumped to the conclusion that the company was struggling to remain independent. The ever-opportunistic Digital Communications Associates (DCA) approached the Board in November with an offer to merge the two companies. The merger bid by DCA was $9.75 per share for a total of $175.5 million. When the UB Board displayed little interest, DCA threatened to begin a tender offer to take hostile control of the company.77 UB responded aggressively saying the transaction was not: “ in the best interest of the company and its shareholders, suppliers and customers.” On November 16, DCA announced that it was dropping its hostile take-over but would hold its roughly one million shares of stock. As word leaked out, the price of UB’s shares dropped $.75 to close at $7.50.78
While UB had defeated the merger bid of DCA, it left Ungermann shaken. Charlie Bass opines:
We just went on the block, and Ralph hires Goldman Sachs and says: “Bring in the best deal. Find out what’s possible.” He, then, starts talking to everybody. He talked to Intel, he talked to HP, he talked to – and that was the best deal. Now, I maintain there didn’t have to be a deal. I mean, this being in play is partly a state of mind, and I think the company did not need to be sold. It was not in trouble. It was simply being hounded. Ralph was tired. Ralph was taking a beating on Wall Street, and he didn’t like it.
In December 1987, conversations began earnestly with Tandem Computers. For Tandem the decision would be a bold act and for UB the merger felt like finding a safe harbor. Ungermann later explains the reason to merge and opines on the 3Com – Bridge merger:
So we’ve had one upstart and two big guys in front of us, but we always knew DEC and IBM were the competition, and now we know for sure, because I am absolutely 100% convinced that 3Com will – that there will be no Bridge division as an effective competitor against us in another two years, because they’re making a decision where they’re going and I knew what that decision is going to be, and it’s going to be over here where they’re successful and where there’s a good market. You see it in the defections of the people, and already we see an enormous difference in their competitiveness out in the field. They’re losing focus and direction in our market, and that’s great. At the same time, we’ve got IBM with more and more capability every day, and so therefore we say: “Oh, geez, we better get to be part of a bigger company, because all these guys are sitting up here saying: ‘Geez, this is a strategic decision, and we only have three strategic vendors, and who’s Ungermann?’” So we said: “We need to be part of a several billion dollar operation,” but we picked a partner who would – who saw things the same way we did. Tandem was a really good partner.
On February 22, 1988 Tandem announced its proposal to acquire UB for $260 million, $85.5 million more than the DCA offer.79 Each UB shareholder would receive $12.50 in cash and the convertible subordinated debenture holders will receive $833.34 per $1,000 of face principal.80
Davidson shared the views of Bass. He explains there was some rationale:
Certainly a concern on the part of major customers for the financial stability of the company if we were going to make bids on multi-multi million dollar commitments, and they asked questions. There would be those who said we ran ahead too quickly. There will be those who could possibly say ‘Well, there were other problems that were going to come to the company if we didn’t get some financial stability.’ I don’t feel like I’m a good spokesman for those kinds of things. I would have – in fact, when the proposal for a merger came, I voted against it, thinking we’re independent, we’re still making money and we can do some great new products if we would just do ‘em. So it took some convincing before I voted for it.
As expected, on March 18, Tandem Computers announced the successful conclusion of its tender offer with 95% of the outstanding shares tendered. The acquisition was formally completed on June 30, 1988. Jim Jordan, no longer with the company, but still knowledgeable about the market explains:
I don’t know about the price, or if they paid too much or anything else, but strategic-wise, if they can absorb it and manage it, it probably makes an awful lot of sense for Tandem. Their main competitor has got to be DEC, and DEC’s more of a networking company than anybody else around right now. DEC’s the biggest competitor Ungermann-Bass has.
In July 1988, Ungermann, now a Vice-President and Director of Tandem, reflects:
I believe you can’t survive without being a strategic vendor, and Tandem has become one of those. It’s only $1.2 billion, $1.3 billion this year, but on the other hand, they are a strategic supplier to a huge number of big companies, and already it’s impacted our business very substantially and significantly, in terms of our opportunity to go in and deal with companies we’d never even think of getting into as a strategic communications supplier. So we’re finding ourselves in more and more situations where IBM and Tandem are the computer company and we’re the networking company. AT&T is the long-haul networking company. So I think it is as necessary part of this evolution, because my view is this information stuff is so critical, you’re out of business without controlling it, and therefore every company is going to focus on it. What we want to do is pick off the leaders in those companies and make sure they implement it right, and then the others will follow. I guarantee you nobody’s going to select a little company to be their strategic communications supplier. So are we big enough? Two billion. Well, we’ve got to grow fast, but Tandem has the reputation and the ability to deliver complex, strategic on-line systems, and therefore, we’ve been able to bid on and win some deals that we just would have not been able to do.
The history of UB as an independent Networking company demonstrates how making just one strategic investment mistake can be the end of independence.
“Offer for Ungermann-Bass is Considered by Company.” WSJ, Nov. 13, 1987, p.
“Unsolicited Bid to Acquire Ungermann-Baa is Dropped,” WSJ, Nov. 16, 1987
“Merger with Tandem Will Give Ungermann-Bass Financial Edge,” PC Week, Feb. 23, 1988, p. 129
“Tandem Woos U-B to Merger,” Communications Week, Feb. 22, 1988, p.1