What's Next for Nortel?

Now that Alcatel and Lucent are talking merger, what does the future hold for Nortel? It's entirely possible gear makers will focus on smaller fish like Juniper and Redback

It's about time. That's how many on Wall Street reacted to the March 23 announcement that Alcatel and Lucent are in merger negotiations. Talk of consolidation among big telecom-equipment makers has been rife for years, and grown louder amid recent mergers by some of the biggest buyers of phone gear.

The past two years have seen the pairing of AT&T (T) and BellSouth, Verizon (VZ) and MCI and Nextel and Sprint (S), to name but a few. As carriers combine networks, they're spending less on equipment. That leaves vendors of those products in a bind that could be unraveled by mergers and acquisitions.

Alcatel (ALA) and Lucent (LU) were quick to say their talks could break down (see BW Online, 3/24/06, "Lucent-Alcatel: A Marriage of Equals?"). But should the discussions result in a deal, it probably won't be the last. Nortel, the largest North American phone-equipment maker, is seen by some as another possible takeover candidate. Its shares rose 4.3% on March 24, the day after the Alcatel-Lucent talks were disclosed.


  Nortel (NT) could be attractive to companies eager to get a foot in the door with North American service providers. Nortel spends $1.9 billion a year on research and development and brings valuable know-how in hot areas like Voice over Internet Protocol (VoIP). It's also a leader in markets ranging from IP calling boxes to softswitches, used to route telecom network traffic.

Optimism for Nortel abounded after Mike Zafirovski, former chief operating officer of Motorola (MOT), became CEO last October. In February, he began taking the wraps off plans to turn around a company that was plagued for years by misreported results, financial restatements and a merry-go-round of CEOs (see BW Online, 2/24/06, "Nortel's Long, Hard Slog").

But doubts resurfaced the following month after the company said it would have to restate several years of financial results yet again (see BW Online, 3/13/06, "No Accounting for Nortel's Woes").


  Analysts say European telecom gear makers Ericsson (ERICY) and Siemens (SI) are among possible acquirers. Still, uncertainties around Nortel's finances could keep would-be acquirers on the sidelines until there's further evidence Zafirovski has begun to right the ship.

"You have no idea of the financials," says Albert Lin, an analyst at American Technology Research in San Francisco. "Unless you get it extremely cheap, how do you know what you are getting?" However unattractive, Nortel will surely be under greater pressure to find a partner should the Lucent-Alcatel combination pan out.

Some analysts point to mid-sized or smaller niche players as attractive targets. "It is not my belief that this will be a harbinger of mega-mergers," Joe Chiasson, an analyst at Susquehanna Financial Group, says of an Alcatel-Lucent deal. While another big pairing could happen, "large, diversified vendors buying vendors with a specialty" may be the likelier scenario.


  In the next few years, some 300 smaller companies will consolidate into as few as 30 gear makers, reckons Susan Eustis, CEO of tech consultancy WinterGreen Research. The tussle for some niche players is already under way. Just days before the Alcatel talks were disclosed, Lucent outbid Ericsson for the assets of Riverstone Networks, a maker of Ethernet infrastructure that was in Chapter 11.

There's no shortage of smaller fish that would help an Alcatel rival fill product gaps. Juniper (JNPR) would be a catch for a player looking to bulk up in routers, which help direct Internet traffic. Juniper would help its acquirer turn up the heat not only on Alcatel and Lucent but also networking giant Cisco (CSCO).

Other takeover candidates include Ciena (CIEN), Sonus Networks (SONS), Tellabs (TLAB) and Redback Networks (RBAK), analysts say. Nortel, Siemens or Cisco might want to acquire Redback to bolster network-access products that enable services such as TV over the Internet. Redback has been gaining share in this market with its special, so-called edge router, says Chiasson.

Don't rule out Asian acquirers either, analysts say. Japanese rivals Fujitsu and NEC, or Chinese rivals Huawei and ZTE could try to gain a foothold in the U.S. by going after well-connected companies such as Tellabs, whose gear sits in nearly every existing network, says Lin. Another possibility: Ciena, whose gear is used by heavyweights like BT Group (BT) and Verizon (VZ), says Muayyad Al-Chalabi, principal at tech researcher Adventis.


  Alcatel and Lucent would become particularly potent in the area of wireless equipment. To compete, Ericsson, Nortel or Motorola might want to beef up their capabilities in WiMax, which enables high-speed wireless Internet access over large areas. Sales of WiMax gear may surge to an eye-popping $20 billion in 2011, from $34 million last year, according to WinterGreen Research. Potential acquisition targets include WiMax gearmakers like Solectek, says Eustis.

This round of telecom equipment mergers was long in the making -- and it may be just getting under way.

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