With a possible buyout of Avaya Inc. in the works, analysts see an opportunity for Nortel Networks Ltd. to strengthen its enterprise business and create potential cost savings by combining the two IP telephony businesses.

According to The Wall Street Journal, Avaya is in discussions with public and private bidders to sell all or a part of its business. A buyout of Avaya would highlight continued consolidation in the telecom equipment market, following megamergers like that between Alcatel and Lucent last year. However, unlike Alcatel-Lucent (NYSE: ALU), Avaya operates primarily in the enterprise space, which thus has far been mostly untouched by consolidation.

In a research note issued this morning, Prudential Equity Group LLC analyst Inder Singh wrote, "We believe the enterprise telephony space is ripe for consolidation, where a large number of competitors continue to face off in the midst of a worldwide market transition to IP telephony."

Rumors of a sale circulated as Avaya postponed its analyst-day meeting, originally scheduled for May 31, which it has yet to reschedule. According to news reports, companies mentioned in connection with a possible sale include Nortel, Cisco Systems Inc. (Nasdaq: CSCO), and private equity firm Silver Lake Partners .

Perhaps most interesting of these possibilities would be a purchase by Nortel, which has seen its share of the IP telephony market fall sharply over the last several years. According to sources in the WSJ, talks between Nortel and Avaya have been ongoing, but cooled recently due to disagreement over price and whether Nortel would pay for Avaya in cash or stock.

JP.MorganChase analyst Ehud Gelblum wrote in a research note today that "a combo cash + stock deal – which seems the most likely of scenarios – would require somewhere between 11 percent and 18 percent opex cuts for NT to offer a 15 percent premium and still have an acrretive deal."

Even so, a Nortel-Avaya mashup could make sense, analysts say, as it would bring more of an IP enterprise focus to a Nortel business that is currently very dependent on legacy product offerings. Sales of networking equipment to corporate customers make up about 25 percent of Nortel's revenue, but according to Singh's research note, the company has seen its share of the IP telephony market fall below 15 percent.

Nortel could have difficulty competing head-on in Cisco's core market alone. However, a combined Nortel-Avaya would be the market leader. Singh estimates that such a combination would "create the dominant vendor in N. America (35 percent total telephony share), EMEA (22 percent share), and S. America (30 percent share), and [would create] a stronger presence in Asia (11 percent share)."

In a phone conversation with Light Reading, Singh said, "I think Nortel has made it clear that they see value in the enterprise and will invest in it" organically and through acquisitions.

Due to a joint venture between Microsoft Corp. (Nasdaq: MSFT) and Nortel earlier this year, Singh also believes "a strategic deal would make tremendous sense for the industry, for Avaya, and for Nortel" because it would bring together three of the largest players in the business. (See Nortel, Microsoft Partner.)

A Nortel-Avaya deal could also fit in with Nortel's restructuring and cost savings plans. Analysts say that with the overlap between the companies' IP businesses, there are more potential cost savings than Nortel could provide on its own in the enterprise space.

Representatives of Nortel could not be reached. An Avaya spokesman declined to comment, saying the company "doesn't comment on rumors or speculation in the market."

— Ryan Lawler, Reporter, Light Reading