April 5, 2004 Technology

Network Technology
Softswitching - Accelerating in 2004

Kenneth W. Muth
Action
kmuth@rwbaird.com Softswitching has become mainstream in 2004, which is a year earlier than we originally
414-765-3773 thought. It allows carriers to offer new services and lowers network operating costs.
Wireline, Cable and Wireless operators as well as Enterprises are all in early
Theodore J. Moreau, CFA deployments with this next-generation equipment. The next-generation equipment
tmoreau@rwbaird.com
414.765.3922
market was $1.3 billion in 2003 and is forecasted to be a $13.0 billion opportunity over
the next four years.
Brad Zoltak
bzoltak@rwbaird.com Summary
414.765.3757
• A Softswitch is a software-based switch that converts a telephone number into an IP
address, or packet, and then switches the call in software to its destination.
• Infonetics estimates the next-generation equipment market will be $14.0 billion
Please refer to ('03-'07). Millennium-Skyline Project predicts the entire U.S. replacement cycle over
"Appendix - 15-20 years for next-generation switching could be about $40 billion.
Important • There are about 2,600 carriers in the U.S with an installed based of 23,650 local
switches, according to Millennium-Skyline.
Disclosures" for • Carriers are upgrading to Softswitches to lower operating costs, handle data and IP
important packets more efficiently as well as offer new services to customers.
disclosures. • Large carrier adoption such as Verizon, SBC, British Telecom, Telecom Italia, Cox,
Comcast, Bell Canada is accelerating the Softswitch market as competing operators
must react in order to stay price competitive and profitable. Carriers now agree that
Softswitch technology is stable, reliable and scalable for deployment and now it is just
a matter of when and where to roll it out.
• From a geography perspective, North America is the early adopter with Asia / Pacific
second and Europe last, which is about 12-18 months behind.
• New services available with Softswitches are VOIP, IP VPNs and IP Centrex. Carriers
can lower operating costs 50%-70% by deploying Softswitches versus operating less
efficient legacy switches.
• There are four addressable markets for Softswitches: Wireline, Cable, Wireless and
Enterprises. Active deployments: Wireline deployments are happening now, cable will
be 2H'04, Wireless in '05 and Enterprise will be '05 / '06.
• Public companies that participate in this market are Nortel, Siemens, Ericsson,
Tekelec, Sonus, Lucent, Alcatel and Cisco.
• Nortel is the best positioned at large carriers due to its DMS (old switch) incumbency,
and its Softswitch product portfolio was commercially available for early customer
trials and now live deployments.
• In the second tier of vendors, we believe Tekelec is well-positioned with its Santera
portfolio for larger deployments and Taqua portfolio for smaller deployments.
April 5, 2004

Details
Next-generation worldwide addressable market - $ in thousands
Total
2003 2004E 2005E 2006E 2007E '03 - '07
Integrated Softswitch $68,160 $130,188 $243,222 $389,809 $517,964 $1,349,343
Circuit-based SS $281,651 $339,419 $389,105 $423,678 $450,944 $1,884,797
Packet-based SS $98,680 $161,854 $479,794 $981,880 $1,423,415 $3,145,623
Total SS $448,491 $631,461 $1,112,121 $1,795,367 $2,392,323 $6,379,763

Media Gateways $696,738 $772,752 $985,538 $1,253,281 $1,521,401 $5,229,710

Session Border Controller $29,035 $52,309 $154,830 $305,712 $453,257 $995,143
Voice App. Server $33,735 $78,579 $161,900 $280,815 $402,978 $958,007
Media Servers $22,532 $42,756 $84,855 $153,703 $217,543 $521,389

Total Next-Gen $1,230,531 $1,577,857 $2,499,244 $3,788,878 $4,987,502 $14,084,012

Source: Infonectics, Inc. - February 2004.

U.S. Central Offices, Number of Lines and Number of Switches

Lines Central
Line Size Switches (in M) Lines / Switch Offices

0 - 5,000 16,742 19.0 1,135 16,742

5,000 - 10,000 2,032 12.5 6,152 2,032
> 10,000 4,876 151.0 30,968 4,876
Total 23,650 182.5 7,717 23,650
Source: Millennium-Skyline Project - December 2003.
According to the Millennium-Skyline report, the RBOCs control about 56%, or 13,376 of
the total central office switches. Independent operating carriers (IOCs) represent the
remaining 10,274 switches but only have about 15% of the total 182 million lines in the
United States. About 90% of the IOCs switches handle less than 5,000 lines. Additionally,
the RBOCs also have the majority of their switches (68%, or 9,031 switches) serve less
than 10,000 lines.
The total number of switches that serve less than 10,000 lines is 17,623 and is the
addressable market for an integrated Softswitch from vendors like Taqua, MetaSwitch
and Telcordia. CirPack also addresses this market but focuses on the international
markets. These integrated Softswitches can range in cost from $200,000-$750,000, with
the average closer to the low end of around $250,000. An integrated Softswitch cost is
dependent on number of lines served and number of customers using the network. Over
the next 15 years, this yields a U.S. market opportunity of $3.5 billion - $5.0 billion.
Additionally, there are about 750 to 1,000 Class 4 (tandem) switches in the U.S. Each
RBOC has between 50-160 Class 4 switches in their respective network. The long
distance carriers MCI, AT&T and Sprint have 75-200 Class 4 switches in their respective
networks. This much smaller addressable market is Sonus Networks primary market of
Softswitch deployments and carriers use its Softswitches and media gateways to switch
traffic from Internet dial-up services.
What Is A Softswitch?
A Softswitch is a centrally located software-based switch that changes a telephone
number (414-765-3773) into an IP address and then routes that IP address to its
destination and converts the packet back into a number. The Softswitch provides call
control, signaling and intelligence. Other devices connect into it such as media gateways,
application servers, media servers and session controllers that provide customers their
services and sit out at the edge of the network. Some services are handled by the
softswitch, but most enhanced services are handled by application servers.

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The significance of this next-generation architecture is that it is able to distribute services

with greater reach than legacy systems as most of the devices such as application
servers sit out at the edge of the network. A softswitch architecture separates the major
functions, such as call processing, call control and management, that are usually handled
within a circuit-switched scenario. The voice call does not go through the Softswitch but
rather the other boxes such as media gateways. This frees up the capacity of the
Softswitch and allows it to have a much greater scalability than a traditional circuit-switch
and eliminates the barrier of call distance from the central office.
This changes the centralized architecture of legacy networks to more distributed / "mesh"
architecture. Large carriers will no longer house the majority of their gear in a central
office but distribute it to the edge of the network. The Softswitch itself may reside in a
central office but the media gateways may be located in an office building up to 1,000
miles from the central office Softswitch. This is a major change and is truly a distributed
architecture.
The physical footprint of a legacy circuit switch compared to a next-gen softswitch can be
as great as 40 to 1. This saves not only a lot of floor space in the carrier's central office
but also saves a lot of power consumption. Operational savings are realized due to
efficiencies in operating fewer pieces of equipment and easier interoperability with other
vendors. In a legacy telephone network, circuits are set up for an end-to-end connection.
However, in a softswitch network, the call is terminated at a gateway and then packetized
for transport over an ATM or IP network. This yields significant operational savings to the
carrier because the network's capacity is used much more efficiently.
Over the next 10-15 years, Softswitches will replace the large legacy tandem
circuit-based TDM (Time Division Multiplexed) that perform similar functionalities. Initially,
larger carriers will run both legacy and the next-generating switching networks, but over
time these carriers will rip out the legacy gear and just operate the newer equipment. It
can take large operators three to four months of planning just to rip out 1 circuit switch.
Different nodes in the network perform different functions and services.
Softswitch - Provides intelligence at the core of the network and is the main "brain" that
performs call control (initiation and breakdown) and SS7 signaling. The Softswitch
controls the other devices to provide customers their services. There are two kinds of
Softswitches - Circuit-based and Packet-based. The Circuit-based Softswitches are being
deployed by the larger carriers today and are made by the traditional OEMs (Nortel,
Lucent, Ericsson and Siemens) who are the incumbent vendors of the traditional
switches. These large operators want to leverage their older infrastructure, but also
achieve next-generation services and lower operating costs.
Most vendors of these Circuit-based Softswitches have upgrade paths to a pure IP
Softswitch in the future through line card and software upgrades. The Packet-based
Softswitches are truly the newer generation switches and are sold by smaller vendors
such as Sonus, Italtel, Tekelec (Santera) and UTStarcom. The ultimate end game for
carriers is an all packet-based Softswitch architecture.
There are two classes of Softswitches.
Class 4 - long-distance (Tandem) switch used for backhaul applications. Fairly simple on
a relative basis to the Class 5 switch. This is a small addressable market.
Class 5 - local switch that connects to PSTN. This is the more complexed switch of the
two categories and it replaces the main Central Office switch. This is a major addressable
market.
Media Gateways - Acts as "access point" to the network - takes TDM voice and
packetizes to IP and then compresses the call at one end of network then reverses that
function at the other end of the network. Media gateways play a significant role in
next-generation networks because it terminates calls from the PSTN. With packet
trunking, carriers can achieve much better load balancing on their network, which lowers
operating costs.
Session Controller - Performs only IP interconnection functions that controls and
manages real time multimedia traffic flows between IP networks.
Voice Application Server - Software-based platform that runs on a server and provides

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IP multimedia services such as unified messaging, self-provisioning, voice VPN and IP

Centrex.

Benefits of a Softswitch
The difference of next-generation Softswitch architecture is the ability to distribute to the
edge of the network (media gateways, application servers and session controllers) up to
1,000 miles away from the hosted Softswitch. This mesh, or distributed, architecture
provides carriers incomparable flexibility in network design and maximum flexibility for
their customers.
Other benefits are:
• Cost savings - capex and opex.
• Open and flexible platform.
• Ease of deployment.
• Initiation of new services in shorter time.
• Scalability.
• Extend geographic coverage (out-of-territory).
There are four addressable market opportunities that will use Softswitches. The major
carriers (Wireline, Wireless and Cable) are deploying this equipment today, but the larger
equipment deployments at the major carriers will likely be 2006 - 2009.
Wireline Network Operators
Large North American Wireline operators (Bell Canada, MCI, SBC, Sprint and Verizon)
have been the first to embrace this next-generation architecture first in their
long-distance, or backhaul, networks and now slowly into their local networks. European
operators like Telecom Italia and British Telecom are among the larger European PTTs
deploying Softswitches in their networks. We believe Wireline Softswitch rollout will first
occur in North America, followed by Asia / Pacific and then Europe.
The large incumbent vendors of traditional switch equipment like Nortel, Lucent, Siemens
and Ericsson will likely win the majority of this marketplace over the long run. Large
carriers are comfortable with these OEMs because of scalability and dependency these
large operators place on these vendors to help run their networks. A large carrier like
Verizon depends on Nortel to take the traffic off of the legacy Nortel DMS switch and
"jump" the traffic onto its new Succession Softswitch platform. Obviously, Nortel has the
best working knowledge of both switches compared to trying to have a new vendor like
Sonus Networks, which could cause interoperability issues.
Changing the Local Switch and The PSTN Network
There are approximately 23,650 local circuit-switches in the U.S. and about 750-1,000
long-distance circuit-switches. The local switches are also known as the public switched
telephone network (PSTN). The PSTN is the combination of the world's public
circuit-switched telephone network, and similar to the Internet, which is based on IP
packet-switched network. The PSTN network started its upgrade from analog to digital
switches in 1997 and took 15 to 20 years to complete.
Over the last three years, carriers have been testing and deploying Class 4 Softswitches
for long-distance backhaul, which does not impact the local network. Now, major telcos
are moving to these local circuit switches, which is a much larger and complicated
endeavor. We believe the large U.S. carriers will upgrade the majority of their local
switches over the next ten years. These operators will start in more urban geographies
because it covers a greater proportion of their network traffic and finish the upgrade in
more random and rural locations.
Verizon stated five main reasons why it is upgrading to a next-generation Softswitch
network: 1) offer new services, 2) exhaust of central offices - out of capacity, 3) old
network is using discontinued gear, 4) FTTP broadband build out and 5) ability to
seamlessly integrate its wireless and wireline networks.
Top Wireline Softswitch vendors to major operators: Nortel, Siemens, Lucent, Ericsson

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and Cisco.
Top Wireline Softswitch vendors to CLECs, IOCs and smaller ILECs: Tekelec (Santera
and Taqua), Sonus, Telcordia, MetaSwitch and CirPack. These smaller carriers with
10,000 lines or less can purchase a very compact Softswitch that has complete
functionality integrated in 1 server-like box. It has the call control and the media gateway
all inside the same box.
Wireless Network Operators
Wireless operators are slower adopters of Softswitching technology because their
networks are newer and the vast majority of their traffic today is voice. There are between
15,000-20,000 mobile switches worldwide that could be converted to a Softswitch
architecture. This yields a worldwide next-generation Wireless equipment market around
$40 billion. As pure 3G (EV-DO or UMTS) networks get commercially launched and data,
INTERNET surfing and e-mails become more prominent on their networks, they will
convert to their switches to Softswitches.
We believe the US Wireless operators will be the first to deploy this technology, followed
by Asia / Pacific region and then Europe. We only know of one Wireless operator,
T-Mobile USA, that is running live traffic with Class 5 Softswitches and Media Gateways.
T-Mobile is using Spatial Wireless Softswitches and Tekelec's Media Gateways, which
Tekelec OEMs to Spatial. Spatial specializes in GSM wireless protocols and Motorola
with its acquisition of Winphoria Networks (ex-Lucent employees) in April 2003 that
specializes in CDMA protocol. AT&T Wireless is using Sonus's Class 4 Softswitch for
some long-distance purposes. Other US Wireless operators are currently in trials but we
believe this market starts its early roll outs in 2005.
Top Softswitch Wireless vendors: Spatial, Motorola (Winphoria), Nortel, Ericsson and
Lucent.
Cable Operators
As the large cable operators roll out voice services in greater masses, they will upgrade
their voice networks to Softswitch platforms. Large cable operators like Time Warner, Cox
and Comcast are utilizing Softswitches today but we expect the cable market to ramp
Softswitch deployments in 2005 and 2006 as additional voice users come on their
networks. Because these operators have a relatively small voice customer base, the
Softswitch equipment market in this vertical is less than $300 million over the long run.
Unless cable operators really take a lot of market share in the consumer voice market,
this will remain the smallest market opportunity. Similar to large Wireline operators, we
think the large cable operators will dual source its next-generation equipment vendors.
Top cable vendors: Cisco, Nortel, Siemens, Cedar Point and Telcordia.
Enterprise
In our opinion, this category will be the last to embrace Softswitch technology. Softswitch
OEMs are partnering with application providers like Sylantro and Broadsoft to provide
enterprise applications such as hosted PBX, IP Centrex, Consumer VOIP, call center and
other desktop applications. The Softswitch OEM sells its main equipment to the service
provider, like Verizon, and then the service provider offers this application to the
enterprise end customer.
Top application vendors: Broadsoft, Sylantro and Nortel.
Worldwide Market share - $ in millions
The chart below lists the market leaders in each major category. An integrated Softswitch
is a solution that has all the functionality in a single box (call control, signaling and media
gateway) and is sold to CLECs and IOCs with 10,000 lines or less. The Softswitch is the
"brain" in large carriers' networks and controls the other next-generation equipment that is
connected to it such as media gateways and application servers. Media gateways
deployed today are mostly ATM switches with DSP cards that takes TDM voice calls and
packetizes them. The true purpose-built media gateways are called Convergence
switches and are made by vendors like Nuera and Tekelec.
Tekelec has investments in three VOIP entities. In early 2002, Tekelec invested a total of
$16.5 million in Telica and Broadsoft and in return owns approximately 15% of equity in

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those two companies. In 2001, Tekelec gave Spatial Wireless signaling code and in
return was granted about 15% equity in that entity. We believe the total value of these
entities combined today is between $300 million - $500 million. This values Tekelec's
equity stakes at $45 million - $75 million.
Telica - a softswitch and media gateway provider.
Broadsoft - a software-based VOIP application provider.
Spatial Wireless - a wireless softswitch provider for GSM/UMTS networks
Remember, this market is very young in its adoption curve and market share statistics
and market sizes can change quickly and dramatically as one or two major carriers starts
to deploy equipment into its network. The market is not sure what Sonus's market share
will be as it is undergoing restatement of its financial statements.

Market Share 2003

Revenue in millions

Integrated Softswitch Softswitch Media Gateways

Taqua $20 33% Italtel $30 4% Cisco $251 33%
Cirpack $3 5% Nortel $166 22% Nortel $108 14%
Other $37 62% UTStarcom $29 4% Lucent $91 12%
Total $59 100% Ericsson $98 13% UTStarcom $69 9%
Other $58 8% Taqua $20 3%
Total $380 50% Other $227 30%
Total $765 100%

Source: Infonectics, Inc. - February 2004.

Next-Generation Equipment Geographic Breakdown

Geographically, the early adopters embracing this next-generation architecture is North
America. In the U.S., every major carrier both Wireline or Wireless is in some trial or
deployment of this technology. Also, the U.S. has the most sophisticated and complexed
Wireline networks in the world that requires more physical equipment replacement over
the long term.
2003 2007E
CALA
CALA
5%
4%

Asia/Pacific NA Asia/Pacific
$0
27% 40% 26%
NA
45%

EMEA EMEA
28% 25%

Source: Infonetics, Inc. - February 2004.

Competition
The market is sliced into a number of different equipment categories for next-generation
equipment.

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April 5, 2004

Next-Generation Vendors

Integrated Softswitch Media Servers

Cedar Point Sentito AudioCodes IP Unity
Cirpack Taqua Cognitronics Snowshore
CopperCom Telica Convedia
MetaSwitch
Circuit-based Softswitch
Media Gateways Alcatel Marconi
Aastra Marconi Ericsson Motorola (Winphoria)
Alcatel Nuera Lucent Nortel
Cirpack Nortel Siemens
Cisco Siemens
Clarent Sonus Packet-based Softswitch
Ericsson Starent Alcatel Spatial
Huawei Stratus Cisco Stratus
Hughes Tekelec Emergent Tekelec
Lucent UTStarcom Huawei Telcordia
Veraz Hughes UTStarcom
Italtel Veraz
Siemens ZTE
Session Controllers Sonus
Acme Packet MediaRing
Jasomi Netrake Voice Application Servers
Kagoor NexTone BayPackets NetCentrex
Broadsoft Nortel
IP Unity Pactoius
Iperia Sylantro
LongBoard Ubiquity
VocalData

SIP Important To Softswitch / Next-Gen Platform

SIP (session initiation protocol) is a relatively new protocol standard that allows
Softswitches, Media Gateways, application servers and other equipment to interface with
each other on a common platform. SIP is a text-based protocol, similar to HTTP, and is
used to initiate interactive communication sessions between users for voice, video and
other multimedia applications, such as gaming.

"Appendix - Important Disclosures"

1 Baird maintains a trading market in the securities of Tekelec .
1 Baird maintains a trading market in the securities of Cisco Systems, Inc.

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Rating and Price Target History for: LU as of 04-03-2004

04/25/01 07/25/01 09/28/01 06/11/02 07/23/02 09/05/02 09/19/02 01/23/03 10/23/03 01/22/04
MO:$20 MO:$12 MO:$9 MO:$5 MO:$3 N:$3 N:$2 O:$3 O:$4 O:$5
10

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Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1
2002 2003 2004

Created by BlueMatrix

Rating and Price Target History for: NT as of 04-03-2004

04/20/01 06/15/01 06/18/01 09/28/01 04/19/02 05/29/02 06/11/02 08/30/02 09/05/02 10/18/02 11/04/02
SB:$30 MO:$30 MO:$15 MO:$9 MO:$7 MO:$5 MO:$3 MO:$2 N:$2 N:$1 N:$2
20

16

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2002 2003 2004
01/24/03 09/12/03 01/08/04 01/30/04
O:$4 O:$5 O:$7 O:$10

Created by BlueMatrix

Rating and Price Target History for: TKLC as of 04-03-2004

05/29/02 08/02/02 09/05/02 10/24/02 01/30/03 07/31/03 10/07/03 10/28/03 01/30/04
I:MO:$16 SB:$16 O:$16 O:$13 N:$11 N:$13 N:$16 O:$19 O:$23
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32

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2002 2003 2004

Created by BlueMatrix

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Rating and Price Target History for: CSCO as of 04-03-2004

01/14/03 02/05/03 03/21/03 05/07/03 08/06/03 11/06/03
I:O:$20 O:$18 O:$17 O:$18 N:$18 N:$22
30

25

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15

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Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1
2002 2003 2004

Created by BlueMatrix

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