We upgrade our recommendation for Tellabs Inc. ( TLAB - Analyst Report ) to Neutral based on its current valuation. The stock price declined more than 49% last year and is currently trading at the low-end of the 52-week price range. We believe this low valuation level may act as cushion in the near term.

In the mean time, Tellabs continues its poor performance. First-quarter 2011 financial results were well below the Zacks Consensus Estimates. The second-quarter 2011 outlook provided by management was disappointing.

What is more disastrous is that Tellabs’ highly reputed high-margin digital cross-connect products are also showing a downtrend. Therefore, gross-margin suffered a set back in the reported quarter and is expected to remain at that low-level in the near term.

Tellabs is facing serious problems in its core wireless backhaul solutions segment. AT&T ( T - Analyst Report ) , the major customer for Tellabs’ 8800 multi-service router decided to upgrade its network with pure Ethernet solutions since the company is moving toward deploying 4G LTE networks. As a result, AT&T is now using Ethernet routers of Cisco and Alcatel-Lucent instead of Tellabs.

During 2010, AT&T generated 35% of total sales of Tellabs and 40% of Data product revenue. We believe loss of businesses from AT&T will have severe consequences on Tellabs’ financials in 2011. We believe loss of revenue from AT&T was primarily attributable to the poor second-quarter 2011 revenue outlook.

Nevertheless, Tellabs is expected to generate top-line growth in the long run supported by significant surge of wireless data traffic that forced the wireless operators to continuously upgrade their networks. This trend will persist in the long run since mobile Internet is flourishing throughout the world through smartphones, tablets, and machine-to-machine communications. More than 56% of Tellabs first quarter of 2011 revenue came from its growth products.

Recently, the two largest mobile operators of Russia, namely Mobile TeleSystems OJSC ( MBT - Snapshot Report ) and Megafon have selected Tellabs to supply mobile backhaul equipments for their respective 3G networks. These two wireless service providers together command 56.6% of Russian market. This deal is a major gain for Tellabs in the fast growing Russian 3G wireless market. Tellabs will deploy its 8600 managed edge systems for IP-based backhaul networks of both operators.