Nortel/Corning: Components Paranoia Grows

A report that Nortel Networks Inc. (NYSE, TSE: NT) and Corning Inc. (NYSE: GLW) are considering a deal that would exchange Nortel's components business for a substantial stake in Corning points to the growing importance of components supply in the optical industry.

Monday morning, the Wall Street Journal reported the two companies were negotiating a deal in which Corning would buy Nortel's optical components business in exchange for $100 billion or more in Corning stock. Light Reading was unable to confirm the negotiations at press time, but a number of experts acknowledged the stakes of the components game are rising with the impending merger between JDSUniphase Inc. (Nasdaq: JDSU) and SDL Inc. (Nasdaq: SDLI).

Even if such talks between Nortel and Corning are progressing, the size and complexity of the deal would present many barriers. Today, Wall Street did not react favorably to such speculation. Corning shares dropped $34.50 (12 percent), to $248.70, in afternoon trading. This in itself presents a problem, as the value of Corning's shares would be used as currency in the deal. Nortel shares rose $0.25 to $81.50.

A deal between Nortel and Corning would have immense impact on the optical networking industry. The perennial shortage of optical components -- which include lasers, chips, and passive components such as wave guides and gratings -- make finding a good supplier crucial to the success of the companies involved. Nortel provides both networking equipment and components and is a competitor with equipment vendors such as Lucent Technologies Inc. (NYSE: LU) and Cisco Systems Inc. (Nasdaq: CSCO), which are business partners with Corning, which supplies a number of optical components including the fiber itself. Lucent also makes some of its own components.

"This brings up the classic question of vertical integration -- if you're an automaker, do you want to make the parts?" says Michael Howard, principal at Infonetics Research. "Part of it might have to do with Nortel wanting to become more lean, like Cisco."

If any such deal is in the making, Howard believes it will come down to an issue of the sway that Nortel could exert over Corning. "It be interesting to see what's the exact control Nortel has over Corning. Will they get special components that are different than what Corning offers to the rest of the industry?" asked Howard.

Indeed, the deal would have numerous implications for Nortel's competitors and their relationships with Corning. According to one former executive of Lucent's optical components business who asked not to be named, Corning requires technology and patents from Lucent to make some of its fiber optic products. If a deal with Corning gave Nortel substantial control over Corning, it would put such releationships at risk.

Corning has been facing increased pressure to find a partner in its competition with JDSU, whose dominance in the optical components market would grow if its proposed merger with SDLI is completed.

Corning, Nortel, and Lucent did not return phone calls by press time.