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Cisco-Nortel? Don't Bet on a Wedding

By Olga Kharif Yes, words do move stock prices. Witness Cisco Systems CEO John Chambers' June 18 keynote speech to the Canadian Telecom Summit. Chambers declared that Cisco would "love to have Nortel as a partner." The stocks of both companies have been in a flutter ever since. Nortel's has risen almost 12.5%, to $4.60 a share. Cisco shares have fallen 3.6%, to around $23.00. The reason: Investors seem to have read into the remarks that Cisco (CSCO) might buy Nortel (NT) while it's down.

The Canadian-based telecom-equipment giant is under investigation by U.S. and Canadian regulators over alleged accounting improprieties. In April, Nortel ousted its top executive team and slashed its stated profits for 2003 by 50%. It's still delaying the issuance of its revised financial statements. "It says a lot about what a John Chambers one-liner can do to a company's stock price," says one top investment banker. "The market forgot that this [Nortel] is a company that can't even get its financial reports out."

"A LOT OF BAGGAGE." Perhaps investors should look harder at what Chambers really said, however. They'll see that a Cisco-Nortel marriage doesn't appear to be in the making. For one, Chambers never mentioned an acquisition, and while he has been mum since uttering his remark, most analysts discount the notion of a buyout. Indeed, "as shareholders, we'd be unhappy with an acquisition," says Peter Hofstra, senior analyst at the $114 million AIC funds, where Cisco is a top-eight holding. "There's a lot of baggage with Nortel we don't want Cisco spending time unpacking."

Moreover, Nortel still wants to maintain its independence: A spokesperson confirms that Nortel's new CEO, William Owens, met with Chambers during the summit. But he also met with about 100 other CEOs. Plus, during his own talk, on June 17, Owens emphasized that his company wants to remain a consolidator -- not an acquisition.

More likely, by mentioning Nortel last week, Chambers was simply applying pressure on Nortel to sign a more favorable partnership deal, in the view of some who follow both companies. The theory goes like this: Cisco wants independent Nortel to do the stuff Cisco doesn't want to do itself, such as telecom service and support. Given that "Nortel is sucking wind at the moment," striking a partnership might provide badly needed revenue for it, says Jim Slaby, an analyst with Boston-based market researcher Yankee Group.

DISTRIBUTION STRATEGIES. Cisco already resells and markets its gear through partners like Nortel's rivals Ericsson (ERICY) and Lucent Technologies (LU). Since Lucent began integrating and selling Cisco's gear in January, 2003, the two companies have also joined forces on providing voice over Internet protocol (VoIP) infrastructure, allowing mobile-service providers to route calls over their data networks. In April, Cisco partnered up with wireless infrastructure heavyweight Ericsson. The two agreed to resell each other's equipment to wireless-service providers.

Any deal with Nortel -- strong in wireless and VoIP -- would likely be similar in nature. Not many wireless startups are on the block that Cisco could acquire to beef up its portfolio, Slaby says. But through a deal with Nortel, Cisco might be able to sell its data and voice products to wireless carriers that buy Nortel's wireless gear.

Indeed, what Cisco really seems to want is access to Nortel's customers. Today, only 25% to 30% of Cisco's total revenue comes from selling to service providers, estimates Mark Sue, an analyst with RBC Capital Markets in New York. The rest trickles in from corporate clients. It has been Cisco's long-time goal to diversify and expand to where service providers add up to 40% or more of its business. A deal with Nortel would be another step in that direction, Sue says.

WEAK HITTERS. Besides, Cisco has often partnered with a company to get a better sense of its products and leadership, says Slaby. Potentially, Cisco might later be interested in only Nortel's wireless business, accounting for about 45% of the Canadian company's revenue. The business is one of a few bright spots in today's telecom market, but Nortel would likely sell it only if the going gets very rough. As for Nortel's other businesses, Cisco probably doesn't want them. Sales of many of Nortel's other products, such as legacy optical switches, are still sluggish, and they aren't expected to pick up any time soon.

A link-up would have other advantages. "In a partnership, typically the strong get stronger, and the weak can survive a bit longer," says AIC's Hofstra. It would also give reassurance to Nortel investors, worried that the gearmaker might not be able to survive, says Ed Snyder, an analyst with Charter Equity Research in San Francisco. "[Nortel's] future could be better because of this deal," he says.

Although Nortel could default, most analysts believe it will get through the hard times. Recently, it announced that former Canadian Deputy Prime Minister John Manley was joining its board. Moreover, most analysts still expect that the restatements, likely to come in the next month, will show Nortel to be profitable. So Snyder, for one, has a buy rating on the stock and expects it to rise to as much as $5.50, nearly 20% above today's stock share price.

Still, a partnership -- not an acquisition -- is what Wall Street should expect. This would mean investors who are buying the Nortel stock in expectations of a merger with Cisco are likely to be disappointed. With Steve Rosenbush in New York and Peter Burrows in Silicon Valley

Kharif covers technology for BusinessWeek Online in Portland, Ore.

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