Telecom-Gear Mergers May Start to Heat Up

HAVING SURVIVED a three-year bust, the suppliers of the gear used in the world’s communications networks are facing a new challenge: the sudden and rapid consolidation of their customers.

A wave of acquisition activity among U.S. wireless and traditional fixed-line carriers — most recently SBC Communications Inc.’s agreement last week to purchase AT&T Corp. for $16 billion — is forcing the telecommunications-equipment companies to ponder their futures, including whether to do deals of their own.

Such transactions have thrust several equipment companies into the spotlight as possible targets, including Lucent Technologies Inc., Nortel Networks Corp. and Marconi Corp.

Lucent’s shares, for instance, rose 3% earlier this week on analyst reports weighing the merits of an acquisition by Motorola Inc., of Schaumburg, Ill. Lucent’s short-term and long-term bonds also rose 3.5% on talk of a potential deal, though the stock fell back, closing yesterday on the New York Stock Exchange at $3.28, down one cent, giving the Murray Hill, N.J., company a market value of about $14.6 billion.

Some of these companies also could become acquirers to strengthen their positions. “We’re interested in partnerships and want to be a consolidator,” said a spokeswoman for Nortel, which is based in Brampton, Ontario.

Another company that could be a potential acquirer, some say, is France’s Alcatel SA, whose planned merger with Lucent collapsed at the last minute in May 2001, in part because Lucent felt the deal was a takeover by Alcatel rather than a merger of equals.

Among other potential suitors, Cisco Systems Inc. and Juniper Networks Inc. may choose to beef up their telecom business through acquisition, analysts said. Both companies are well positioned for the telecom industry’s shift to Internet protocol-based equipment, but much less so in the wireless business.

The consolidation comes on top of an already shrunken market from the boom years of the 1990s.

Compared with the year 2000 at the height of the boom, U.S. equipment spending has been nearly halved to about $45 billion last year, according to Lehman Brothers. After several years of sharp cutbacks in spending by carriers, U.S. investment in new equipment last year rose by 5% and is expected to rise by 4% this year, according to Lehman Brothers.

“The real issue is growth,” says Krish Prabhu, a former Alcatel executive who is chief executive of Tellabs Inc., a maker of broadband equipment and other telecom products based in Naperville, Ill. “If our customers are spending only 4% to 5% more this year than last year that is just not enough for all these suppliers to survive.”

The spate of recent merger-and-acquisition activity among the carriers — and the likelihood of more on the way — tightens the market further and finally may push some reluctant big players to consolidate themselves.

“The consolidation caught the vendor community flat-footed,” said William Markey, general partner with RelevantC Business Group (RCBG), a Chicago-based telecom-consulting firm. “With fewer total accounts, the stakes are that much higher for any supplier in the industry.”

Cisco, with a market capitalization of about $116 billion, long has been interested in turning Lucent, which derives more than half of its revenue from wireless, into a service company that would act as a partner in designing networks and selling to carriers. What’s more, traditional telecom vendors such as Lucent and Nortel still have better relationships with the carriers than do Cisco and Juniper, making them appealing to those looking for a bigger slice of the telecom pie.

A wild card in the potential shakeout is the Chinese telecom- equipment companies, namely Huawei Technologies Inc. Huawei’s international presence has soared in the past couple of years, first in developing markets and more recently in Western Europe. It has just begun to win some small contracts in the U.S.

The surest sign yet of Huawei’s global ambitions: It recently secured a $10 billion loan from the Chinese government to help fuel its expansion.

“The Chinese vendors are flush with cash,” said Mark Sue, an analyst with RBC Capital Markets in New York. “All of them have been very active in courting partners, which could turn into acquisitions.”

Any consolidation among the vendors is expected to start among domestic partners. The reason is that much of the global equipment industry is still very much segmented along national lines. The big European carriers typically turn to European vendors such as Siemens AG, Alcatel or Telefon AB L.M. Ericsson. The North American carriers, on the other hand, favor the likes of Lucent, Motorola or Nortel.

In the short-term, smaller vendors unable to compete for the ever- larger spending projects by the carriers are the most likely to be snapped up, consultants and analysts said. More deals between midsize vendors also are likely, such as Tellabs’s $1.5 billion acquisition of Advanced Fibre Communications Inc. last autumn.

“What we will see is more of the big entities buying the small ones, rather than mergers among the bigger ones,” said John Ryan, president of RHK Inc., a telecom-research firm in San Francisco. The reason: Spending by the dwindling number of carriers in the U.S. is for increasingly larger and more complicated projects, which usually are beyond the capabilities of the smaller vendors, he said.

Those projects include the massive rollouts of fiber networks, broadband services, Internet phoning and other equipment as the carriers evolve from traditional providers of voice services to modern media companies capable of delivering data, video and audio, as well as voice.

Sprint Corp.’s planned merger with Nextel Communications Inc. is expected to hurt Motorola, since it provides Nextel’s successful push- to-talk phones and equipment, making it Nextel’s biggest vendor. The combined company’s future network spending could favor Sprint’s traditional vendors, namely Lucent and Nortel.

“That assumes we remain static,” said Richard Nottenburg, head of corporate strategy and mergers and acquisitions for Motorola. “But we think this consolidation provides a lot of opportunities for us in helping to bring these disparate networks together.”

Others suggest that, given the size of the global telecom market and the new spending under way, the recent carrier consolidation in the U.S. might not change things too much for the bigger vendors.

The three most recent carrier deals, as well as a potential acquisition of MCI Inc. by Qwest Communications International Inc., will shave equipment spending in the U.S. by $850 million next year, and $600 million the year after, according to Steve Levy, an analyst with Lehman. That is just 1.6% and 1.1% of the total expected equipment spending for those two years, respectively, he said.

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