With so many optical startups chasing so few carrier customers, it once seemed that 2001 might be a banner year for the mergers and acquisitions business.

But no. There have been about 114 M&A deals totaling $7.2 billion so far this year among service providers and equipment companies, according to Dealogic. In 2000, there had been 205 M&A deals totaling $49 billion.

{Image 1}What's going on? Analysts and M&A advisors say that three things have prompted the abatement of last year's M&A frenzy.

First, equipment makers and service providers have been more worried about bailing water from their own ships than raiding competing vessels. That’s why Alcatel SA (NYSE: ALA; Paris: CGEP:PA) chairman Serge Tchuruk told the French newspaper Le Monde that his company would sell 50 factories between now and the end of next year.

Second, another M&A inhibitor is debt, much of it brought on as big companies financed ridiculous deals with unstable customers just so they could show shareholders some revenue growth. Look at the ill-fated proposed combination of Lucent Technologies Inc. (NYSE: LU) and Alcatel. It had been reported that the companies expected to save $4 billion by combining. But such savings were paltry compared to the $7 billion in debt the marriage would have created (see Alcatel: What's Next?).

Last but not least, companies that previously had a ravenous appetite for M&A deals have seen their deal currency (shares) drop in value between 30 and 90 percent in the past year. Look at Nortel Networks Corp. (NYSE/Toronto: NT). By this time last year it had acquired Promatory Communications, Dimension Enterprises, Xros, CoreTek, Architel Systems, and Photonic Technologies for about $6 billion. It had also announced it would buy Alteon WebSystems and EPiCON, adding another $8 billion to its M&A tally. This year, however, Nortel has only made one deal -- a $2.5 billion acquisition of JDS Uniphase Inc.'s (Nasdaq: JDSU; Toronto: JDU) Zurich-based subsidiary, as well as some related assets in New York.

Of course, Nortel’s not alone in its journey from being a bold buyer to a timid company in transition. Now that there are fewer buyers in the sector, buyer behavior has changed, says Gil Livnah, a principal at Broadview International LLC, the firm that advised Xircom in March when Intel Corp. (Nasdaq: INTC) bought it for $748 million. As buyers feel less competition for deals, they’ll take time to do careful due diligence, he says, and they’ll structure deals to place more risk on the sellers. One way of doing this is for the acquiring firm to structure an earn-out, which states that some part of the target company’s sale price would be paid after certain business goals are met.

Startups and their backers are also acting differently now that the chances of being bought aren’t as great as they once were. “There’s a clear need for consolidation, and that’s why you see that venture capitalists are starving the weak companies and feeding the strong ones,” says Ed Ogonek, CEO of Akara Corp., which just closed a $30 million funding round (see Akara Lands $30M in Round Two).

In response, many startups are forging partnerships with larger companies early on, in order to explore reseller arrangements and possible customer trials. “Optical systems startups used to wait until they were far down the road with a product before they hired any sales or business development people,” says Ogonek, who feels that nowadays it makes more sense for a startup to talk to potential customers as early as possible so it can keep an eye on how its customers' needs might change.

There’s no telling exactly when M&A activity will revive. But there are some signs that might signal a comeback. When the stock market stabilizes and there’s a consensus that it has hit bottom, corporate boardrooms will entertain M&A deals more readily that they do now, says Broadview's Livnah.

And when corporate chiefs begin to articulate that visibility for their businesses has improved, companies looking for deals will grow more confident that they can get a good buy. “Companies have to be able to show significant customers, even if they’re just trying to raise money,” Livnah says.

In any case, M&A activity will pick up. It will have to, especially if companies that actively buy companies so they can expand into new markets -- like Cisco Systems Inc. (Nasdaq: CSCO) -- plan on keeping up with their competitors’ technologies.

But no one can pinpoint when the economic slowdown will allow for M&A doors to swing open again. So public companies continue to cut deeper than they probably have to. And private companies continue to stretch each funding dollar as far as it will go. “The approach companies are taking is to assume it’s going to take longer than you think,” says Akara's Ogonek.

- Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com