The Savvy Behind Sycamore

Can even a proven team deliver on this switchmaker's astonishing IPO?

Gururaj Deshpande and Daniel E. Smith talk like winners. Never mind that they're sitting in the barren conference room of a Chelmsford (Mass.) corporate headquarters so nondescript that even their venture backers wonder if it's too cheap. Or that Sycamore Networks Corp., the optical-networking startup where Deshpande is chairman and Smith is CEO, has had cumulative revenues of just $31 million and a net loss of $25 million during its 15-month life span. Forget the fact that Sycamore is drawing fire from the likes of giants Nortel Networks, Lucent Technologies, and Cisco Systems. "We're setting the rules of the game," insists Smith.

What makes him so confident? Little Sycamore has the jump on what is emerging as one of the hottest markets in the telecommunications-equipment business--selling gear that lets telecom companies quickly boost or reduce the capacity of their fiber-optic networks. The nascent market is expected to jump from $200 million this year, to $3 billion in 2002, according to market researcher RHK Inc. Sycamore's so-called optical switch, introduced in May, has a nine-month technology lead on competitors such as Lucent and Nortel, say analysts. And, thanks to the company's first major deal, announced on Nov. 22, with Williams Communications Group, it is the first supplier to land a blue-chip customer. Sycamore's future seems so bright that since its Oct. 26 initial public offering, investors have pushed the share price up 533%, to $240, valuing the company at a dizzying $18.8 billion.

Yet Sycamore could turn out to be far more than the latest Wall Street darling. Experts say its products could hasten the long-awaited day when the Web becomes a fire hose of spewing digital bits rather than the garden hose it is now. High-capacity fiber crisscrosses the country, but network operators haven't figured out a cost-effective way to manage the ups and downs of customer demand. Sycamore uses software to minimize the number of times optical signals are converted to electrical signals and vice-versa. The jump in efficiency makes it possible to run a spate of new Internet services through speedy fiber networks--things like TV-quality video for consumers and big software applications for corporations.

Deshpande and Smith have pioneered a market before--and triumphed. Their prior company, Cascade Communications Corp., was the early leader in switches to handle the soaring demand for data traffic over conventional phone networks. Like Sycamore, Cascade coupled its switches with software that made networks easier to manage. That proved key to winning business from most of the big telecom companies. Deshpande and Smith routinely beat Cisco before they sold the company to Ascend Communications Inc. for $3.7 billion in 1997. "Cascade is the only company that has competed head to head against Cisco and won," says Frank Dzubeck, an analyst at market researcher Communications Network Architects Inc.

FAST ACTION. This time, the two claim they don't plan on selling out early. They believe Sycamore can grow rapidly by focusing on one market and introducing products more quickly than its larger competitors. Example: Williams got a cold shoulder from large suppliers in 1998 when it first went shopping for an optical switch--but Sycamore was able to develop a prototype in just five months. On Dec. 8, the company is introducing a speedier switch that it claims will reduce the time required to add new optical network capacity from six days to six minutes. "Doing another Cascade is not that interesting," says Deshpande. "That was like winning a 100-meter race. This time, we're trying to win a marathon."

Once again, Deshpande and Smith are facing off against the biggest names in the business. And while Sycamore's huge market capitalization makes the company impossible to ignore and improves the odds of staying independent, it also raises expectations. Sycamore's revenues are expected to grow to about $83 million in 2000, analysts project, while profits won't show up until 2001 at the earliest. The game plan calls for Sycamore to add at least one new customer each quarter for the next three years, but if the company falls off that pace, the resulting loss of momentum would be a serious blow to its stock price. One Boston venture capitalist who knows Deshpande and Smith thinks Sycamore's soaring valuation has quickly turned into a liability for the young company, saddling it with unattainable expectations. "It's not a question of their excellence," he says. "It's whether their excellence could possibly be worth all this money. This puts a tremendous amount of pressure on them."

That pressure will test a management duo that has hung together for a decade. They're a classic tech-industry tag team, with Deshpande the technical visionary and Smith the operations guy. They first met in 1991, when Deshpande was looking for a CEO to run Cascade. A recruiter got them together at a Mongolian restaurant in Washington, where Deshpande tried in vain to get Smith to taste the spicier dishes. Today, Smith still orders milder food while Deshpande goes for curries, but in most other respects, the partners see eye to eye.

As Sycamore's chairman, Deshpande, 49, sets the technical direction and works closely with the company's engineers to design products. Analysts credit him with being one of the first to see that network operators could make better use of fiber optics. Although he lacked background in optical technology, Deshpande spotted the opportunity through contacts with researchers at Massachusetts Institute of Technology. "He's very rich, and technically savvy, but he's also very humble. That has allowed Desh to learn new things and grasp the next step in the optical revolution," says Mukesh Chatter, vice-president of the InterNetworking Systems Group at competitor Lucent Technologies.

By experience and temperament, Smith, 50, is more suited to the role of managing Sycamore's day-to-day business. He's detail-driven and unflappable. And he manages by outlining the opportunities and driving them home in terms that everybody in the company can understand. "He sets milestones--things like: `Get me this customer, and I will get you another billion in valuation,"' says Ryker Young, Sycamore's vice-president for sales. He also serves as the public face for Sycamore with investors, handling the recent road show and overseeing the company's finances.

PLAYING ROUGH. It took the skills of both to land the deal with Williams. At a crucial meeting with Williams' top execs in Tulsa, Deshpande led off by laying out Sycamore's vision. Then Smith took over, reminding them that he and Deshpande had delivered on their promises to Williams when they ran Cascade. Williams went for it: The company plans to spend $400 million over the next four years on Sycamore's switches. Says Matthew W. Bross, Williams' chief technology officer: "When one of them makes a commitment, the other one delivers."

Both men have delivered in competitive situations since they were teenagers. A swimmer in high school and college, Smith turned to water polo after graduation "because it had a lot of contact." His ability to shove opponents under water earned him the role of team enforcer, physically intimidating the other team's leading scorer. When Smith left Ascend last year, he worked so hard at improving his golf game that he tore a muscle in his rib cage while swinging at a ball on Weekapaug Golf Course in Rhode Island. Smith is constantly reminding Syca- more's engineers and managers that speed is critical if the company is to survive. "We have an eight-hour lead on the posse and a fast horse," he says.

Smith has always favored working in a small organization over a big one. He requested destroyer duty during his two-year stint in the U.S. Navy because, he says, "on a smaller ship, you can have an impact sooner." His first job after getting an MBA from Harvard University was selling telephone gear for Rolm Corp. in New York, where he went up against big players such as Nortel Networks and Lucent Technologies, which was then part of AT&T.

While Smith was developing sales skills, Deshpande was mastering the intricacies of network technology. He earned a PhD in engineering at Queen's University in Canada. Then, in 1980, he took an engineering job at Codex Corp., an Ontario-based subsidiary of Motorola Inc., and discovered that he loved turning theory into products. But his first foray as an entrepreneur, co-founding network-hardware company Coral Network Corp. in 1988, was hardly auspicious. Deshpande misjudged the market, and the company was sold in 1990 for a measly $15 million.

Still, Deshpande had been bitten by the startup bug and was convinced that telecom outfits would pay for a new type of switch that would allow them to offer different levels of service and guarantee the speed of a customer's connection. On the strength of that idea, Deshpande founded Cascade in 1991.

For all their past successes, Smith and Deshpande are unassuming. Sycamore's suburban Boston headquarters is as spartan as it gets: mostly bare walls and windowless offices for everyone, including the two founders. That's partly by design, an attempt to prevent complacency and to promote an egalitarian, bottom-up culture.

That spartan style comes naturally to both Smith and Deshpande. Neither of them has accumulated the trophies--or the attitude--that often accompany significant wealth. Smith, whose Sycamore holdings are worth $3.5 billion, drives a 10-year-old Volvo station wagon. For Deshpande, whose stake is worth $5.4 billion, the new home he's building is his one outward concession to wealth.

"BIGGER, BADDER, BETTER." They would not be successful entrepreneurs without healthy egos, though. Associates close to both men say their drive to start another company was fueled in part by frustration that they surrendered 60% of Cascade to venture capitalists--and by a nagging conviction that Cascade was worth more than the $3.7 billion Ascend paid for it. "There's some ego on the line for Dan and Desh to do it bigger, badder, better--and own more of it this time around," says analyst Paul Johnson of BancBoston Robertson Stephens Inc.

Deshpande denies he harbors any resentment. Instead, both Deshpande and Smith say they were drawn back into the entrepreneurial arena because they thrive on the challenge of outrunning big competitors. In the summer of 1998, Deshpande drove down to Rhode Island, where Smith was enjoying the beach life with his family. After Deshpande laid out his plans, he reminded Smith how hard it would be to take on the entrenched incumbents and win. "That was the hook," says Deshpande. "Then I knew I had him."

If Sycamore can stick to its game plan, Deshpande and Smith may indeed turn it into a major player in the networking industry. "They're still a couple of hungry guys," says Paul Ferri, a managing partner at venture-capital firm Matrix Partners, which owns 16.4% of Sycamore and was an early backer of Cascade. Hunger is what it will take to beat the giants--and resist the temptation to sell out early again.

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