Nortel and Huawei's Broadband Bet

The telecom-equipment makers join forces to conquer the rapidly expanding market for speedy access to online video

As of 2005, about 5 million people around the world were using superfast Internet connections to watch TV, movies, and other video content. That tally is expected to surge to 70 million by 2010, according to researcher Parks Associates. In an effort to fuel -- and meet -- that demand, services providers the world over are spending billions of dollars to upgrade networks and cable systems.

Enter telecom-equipment heavyweights Nortel Networks (NT) and Huawei Technologies. On Feb. 1 the companies announced a venture that will let them jointly develop gear for use in broadband networks that carry video content. Canada's Nortel and China's Huawei will pool technology and know-how to tap the $9 billion broadband-access market, which is expected to grow 8% this year.

Growth in that market will only accelerate, rising as high as 25% in coming years, as more telecom service providers and other outfits get in on the act, says Susan Eustis, chief executive of tech consultancy WinterGreen Research in Lexington, Mass.

Phone companies such as Verizon Communications (VZ) and AT&T (T) are rushing into so-called Internet-protocol TV in a battle with cable operators such as Comcast (CMCSA). Content providers such as Walt Disney (DIS) and Web powerhouses like Yahoo! (YHOO) may also join the fray, Eustis reckons.


  The venture makes a lot of sense for Nortel and Huawei, analysts say. The North American market accounts for more than half of the world's telecom spending, and Huawei still only owns a small share of it. Nortel needs all the help it can get as it tries to climb out of the red and win back investors' confidence, after an accounting scandal led to management upheaval and results restatements.

It won't be easy, but if the two companies can execute well as a team, they could elbow into a market now owned by Cisco Systems (CSCO), Alcatel (ALA), and Lucent Technologies (LU). "For telcos today, [this technology] is No. 1 or No. 2 priority in terms of strategic thrusts," says Walt Megura, general manager of broadband networks at Nortel.

The companies are already working as a team. Together they're bidding for contracts from the biggest telecom providers in the U.S. -- AT&T (T), Verizon, and BellSouth (BLS) -- Megura says. Nortel and Huawei also have started joint product development. The labor may yield its first fruit as soon as the third quarter.


  The broadband bet may be just the beginning of the cooperation, adds Megura. The partners could later band together on other products, he says, without being more specific. One of many possibilities: collaboration on WiMax equipment, enabling wireless broadband access over large areas, says Paul Sagawa, an analyst at Sanford Bernstein.

At the outset, the companies will direct efforts at the North American market, says Megura. Still, the alliance with Huawei, the dominant gearmaker in China, could benefit Nortel in the Middle Kingdom down the road. While China only accounts for about 7% of global telecom-gear sales, it's the world's fastest-growing market, according to WinterGreen Research.

Partnering with Huawei is further evidence of efforts by newly appointed Nortel CEO Mike Zafirovski to right the ship (see BW Online, 1/26/06, "Nortel's New Lease on Life"). The joint-venture news comes on the heels of a Feb. 1 announcement that Nortel secured a $1.3 billion credit facility. "Mike Z. plays to win," Megura says.


  To be sure, Nortel and Huawei will face stiff competition. Alcatel, Lucent, Siemens (SI), and Cisco all have their sights set on the TV-over-broadband market. Alcatel recently announced new contracts for build-outs of next-generation broadband networks in Lebanon and Denmark.

In October, Lucent announced a new platform for multimedia delivery over broadband lines. And Cisco showed its interest in the telco-TV market with its acquisition of set-top box maker Scientific-Atlanta (see BW Online, 11/18/05, "Cisco's Bold New TV Bet").

Another challenge, at least for Huawei, is the difficulty of penetrating the North American market. In 2003, Huawei established a joint venture with Cisco rival 3Com (COMS). The alliance sells the companies' routers and switches, which are used by corporate customers to direct Internet traffic.


  While it has helped Huawei add share in some pockets of the U.S. market, the gains have not met expecations. Says American Technology Research analyst Albert Lin, "[Huawei was] disappointed 3Com didn't bring [it] better distribution in the U.S." Huawei could not be reached for comment.

In December, 3Com announced it would assume majority ownership of the Huawei-3Com joint venture -- a possible sign of a shift in Huawei's strategy for conquering North America. The ownership change is pending Chinese government approval.

"We are very pleased with the performance of the joint venture," says a 3Com spokesman, pointing out that the Huawei-3Com partnership focuses on a completely different market than the Nortel venture. 3Com's revenue from the venture grew 37% sequentially in its quarter ending in December, but reached only around $20 million (see BW Online, 1/24/06, "Is 3Com Meshing Yet?").


  Huawei likely is hoping the Nortel partnership will fare better. France's Alcatel spent $4.4 billion to acquire DCS in 1998 to gain a foothold in the U.S. access market. Thanks to that and several later acquisitions, Alcatel dominates that American market today, according to WinterGreen. "The same could happen here," says Eustis.

"We believe the cooperation with Nortel, a leader in the telecommunications industry, will enable us to create greater value for our customers," Yafang Sun, chairwoman of Huawei, said in a statement. Nortel's Megura is equally upbeat: "If we do this right, there's a tremendous revenue opportunity," he says. That's a big "if" -- but the size of the opportunity may make the bet worthwhile.

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