As the rumor mill churns, the Light Reading Index burns. Talk of potential deals appears to be driving action in the telecom equipment sector. The rumor du jour: Alcatel SA (NYSE: ALA; Paris: CGEP:PA) kicking the tires at Riverstone Networks Inc. (Nasdaq: RSTN).

The rumor is being taken with a grain of salt by many. Alcatel has a reputation for being finicky and talking to just about every company in North America. For example, Alcatel's last deal, to buy Astral Point for $135M, was nearly two years in the making (see Alcatel Acquires Astral Point -- Cheap and Alcatel Seeks to Buy Optical Startup).

"There have been so many 'Alcatel/Somebody' rumors, I don't pay any attention anymore," says one hedge fund manager who declined to be named.

The potential merger would make sense. Alcatel has been hunting for some metro Ethernet gear ever since its Packet Engines division imploded (see Alcatel's Packet Engines Break Down). And according to analysts covering Riverstone, Alcatel and Riverstone signed a reseller agreement back in January. In this agreement, Alcatel has agreed to resell Riverstone’s equipment through its sales channel. It’s not known if the boxes will be sold under the Riverstone label or under Alcatel’s.

Riverstone stock has risen 50 percent this week on talk of the deal. Meanwhile, other M&A scuttlebutt -- such as Cisco Systems Inc. (Nasdaq: CSCO) possibly buying Sonus Networks Inc. (Nasdaq: SONS) -- may be contributing to the sense that the telecommunications industry is bottoming (see Cisco Eyeing Sonus). The Light Reading Index has risen nearly 20 percent in the past week.

Talks between Alcatel and Riverstone appear be in the very early stages, say Wall Street sources who asked not to be named.

”This is far from a done deal,” says one analyst. “There’s a big difference between having interest and writing a check.”

Both Alcatel and Riverstone have refused to comment directly on the rumors.

Of all the hints as to a possible deal, the secretive reseller agreement may be the biggest.

Analysts like Sam Wilson of Merrill Lynch & Co. Inc. say that the reseller agreement is common knowledge on the Street. But neither Alcatel nor Riverstone have announced it, and neither would comment. While the reseller agreement may still be hush-hush, the two companies have announced interoperability between Alcatel ATM switches and Riverstone’s RS8600.

The closest that Alcatel has come to having an Ethernet portfolio is through its 1999 acquisition of Xylan, an Etherent switch startup focused on enterprise IP voice applications. But Bill Flanagan, a principal analyst with market research firm Burton Group, says the Xylan products aren’t enough for the metro market.

”Riverstone’s products would complement what Alcatel already has,” he says. “Riverstone has hybrid fiber coax cabling, and that works well with Alcatel’s DSL offering. The Omni products from Xylan weren’t designed for that.”

While the acquisition might seem like a good fit for Alcatel, it wouldn’t necessarily make that much sense for Riverstone, say observers.

“There is no balance-sheet reason why the company would have to sell itself,” says Merrill Lynch’s Wilson. “Strategically, it’s a good fit for Alcatel and for others. But typically, companies don’t want to sell just because there is a minor hiccup in their business.”

In fact, sources have indicated that Alcatel approached Riverstone this summer about a possible acquisition, but Riverstone’s management declined the offer.

A Riverstone spokesperson says he has no knowledge of previous talks and declined to comment on the current rumors. But a spokesperson from Alcatel indicates it wouldn’t be too farfetched.

“We have discussions with lots of companies,” says Alcatel's Brian Murphy. “It wouldn’t surprise me if we had discussions with them in the past.”

— Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.com