Redback Networks Inc. (Nasdaq: RBAK) announced today that it would acquire Merlin Systems, a privately held optical networking company, in an all-stock deal worth about $57 million (see Redback to Pay $57M for Merlin).

Redback and Merlin Systems had a call option (an option to buy shares at a predetermined price at a preset deadline) between the two companies that was issued on November 7, 2000. According to Redback's filings with the SEC, the value of the call option was between $53 million and $958 million, depending on product development and sales milestones.

That Redback is getting Merlin at the bottom of the call option price range shows how quickly the economy has slowed down and how much more willing venture capitalists are to unload a small company than to see it through several rounds of private funding.

Merlin Systems, founded in March 2000, helped build Redback's SmartEdge 100 product, a smaller version of Redback's Sonet add/drop multiplexer, the SmartEdge 800, which allows carriers to consolidate various optical and electrical bandwidth connections in metropolitan networks.

The SmartEdge 100, which was announced in January, mainly competes with Cisco Systems Inc.'s (Nasdaq: CSCO) ADM, the ONS 15327 (see Redback's Got a Mini-Me, Too).

U.S. Venture Partners (USVP) and Artiman Ventures backed Merlin Systems, which is led by Cisco veteran Kevin Dickson. USVP's Stu Phillips and Artiman's Amit Shah, both Cisco veterans, served on the company's board. Neither venture firm will say how much it had invested in Merlin Systems, but data from Venture Economics shows that USVP had invested at least $6 million late last year.

Merlin is said to have about 50 employees -- 40 of which are engineers -- at its headquarters in Fremont, Calif. It's not yet clear if all of those positions will be spared during the acquisition. But Redback itself has done some staff trimming, as it let go 150 employees in early April (see Redback Hits the Wall).

Redback Networks has had its fair share of turbulence as its business has shifted to selling more optical networking gear. Redback insiders maintain that the company’s main difficulties are related to operations, not its technology.

“Redback's problems are not technology-related. The problem is that they can't find their ass with both hands in broad daylight,” says one source close to the company.

Redback’s CEO, Vivek Ragavan, recently resigned in an effort to remedy the firm’s ass-finding troubles. Filling his shoes for now is Chairman Pierre Lamond, a venture capitalist who either has board seats on or works closely with at least seven other companies (see Redback's CEO Resigns). This leaves the firm’s day-to-day operations up to a committee of executives who are mostly from larger firms, such as Cisco, and weren’t on board with Redback through its early glory days.

USVP’s Phillips says he's not worried about Redback's execution problems of late. "They were not germane to what was going on at Merlin," he says.

Redback shares had dropped 0.48 (2.96%) to 15.74 in trading late Friday afternoon.

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