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M&A Cheat Sheet

The dirty little secrets of the big bad deals

March 23, 2005

7 Min Read
M&A Cheat Sheet

Telecom equipment M&A rumors are popping up like tulips in Tennessee. So it's time to catch up with what's going on. Are we ready for the next Normenscatoni? (See Introducing... Normenscatoni! .)

The quick answer: Not quite. The industry is definitely being forced to consolidate. Unfortunately, some larger issues, mostly involving how to manage the workforce and corporate pensions, are still barriers to making many of the bigger equipment deals work (see Notes From Naperville and Lucent Offshoring Wave Hits Hard). But hey, at least folks are trying.

Much of the chatter is being driven by merger activity at the top of the pyramid, including the recent merger of large wireless service providers, the forthcoming acquisition of AT&Tby SBC, and the potential acquisition of MCI by either Qwest or Verizon. (See Battle for MCI Heats Up, Poll Takers Favor AT&T, Verizon's 'Beachfront Property', SBC/AT&T Shuffles Wireline Stats, Qwest/MCI Could Chill Gear Sales, and SBC/AT&T: How Painful for Vendors?)

As one investor describes it, the pool of capital spending is being narrowed into a smaller, more concentrated batch of service providers, and that will inevitable force the suppliers to consider banding together.

"There's going to be fewer and fewer [service provider] contracts, but they are going to be larger and larger," says Phil Becker, a senior advisor with Wasserstein Ventures. "If you haven't won the three contracts out to bid for the year, you may not have anything for years."

So you want to hear the latest thinking on who's considering mating with whom? I've decided to bundle all of the most common M&A rumors and the latest thinking in one neat little space below, so you can spend less time chatting at the water cooler (or reading Light Reading's message boards):

  • Lucent/Motorola
    This rumor has been so widely circulated, it was being repeated by the guy at the local deli. Only one problem: There doesn't seem to be a lot of meat on dem bones.

    There's no doubt that Motorola is getting acquisition happy on the telecom equipment front, and it definitely wants more core infrastructure exposure (see Moto's in a Buying Mood). But would it really see Lucent as the way to do this?

    Yes, the two have talked (but who hasn't?). At least one reliable source has confirmed this. However, as have many other potential Lucent suitors (should we call them "Lutors?"), Motorola has concluded that Lucent's large and mysterious pension obligation is radioactive – and Motorola CEO Ed Zander is said to cower under the table whenever a lawyer mumbles "pension liability." (See Lucent Numbers Raise Pension Question.)

    Others say this deal is just idle chatter, generated by investment bankers desperate for a big deal. "It just sounds like an idea from the investment banking community to me," says Frank Dzubeck, president of Communications Network Architects. "I think buying Lucent would set Motorola back, and Motorola stock would tank."

    Good point.

  • Lucent/Alcatel
    Meanwhile, back in Murray Hill and Paris, the Odd Couple have reportedly re-established contact, though there's no word yet on whether a therapist is involved. Keep in mind that Lucent and Alcatel almost merged once before. (See Lucent/Alcatel Rumors Fly, Alcatel/Lucent Work Continues, Alcatel, Lucent Throw in the Towel, and We'll Always Have Jersey.)

    Again, the problem here is that Lucent's pension may smell like a block of stale North American paté to the French. And then there's the matter of Bell Labs. It's assumed that the U.S. Federal government would require Lucent to divest Bell Labs before selling itself to a foreign company, but nobody has proposed a clear path to how this would happen – or who would want Bell Labs, the world's most expensive science fair.

    One thing is certain about both these Lucent rumors (shall we call them "Lumors"?): Chairman and CEO Patricia Russo is definitely looking for an exit strategy, say sources close to the company.

    "Pat does not want the status quo," says one former Lucent executive who declines to be named. "She wants a way out... They are not going to stay independent."

    So who'll take Lucent? That's the $12 billion question (Lucent's market capitalization as of today).

  • Nortel/Whomever
    Spring thaw is coming to the Great White North, and like some awkward juvenile Grizzly bear coming out of hibernation, Nortel has been trying to get back into the mating dance – let's just hope it doesn't maul somebody.

    Several sources say Nortel continues to sniff around the startup space, especially in the access markets. Its OEM partner, broadband access vendor Calix Networks comes to mind first. But Nortel's currency is as shaky as a wooden nickel. Its stock price has recently been drifting below $3. It would likely have to pay cash – and probably quite a bit of it – which would further drain its precious balance sheet. And if you're Calix and revenues are building, why not just hold out for the IPO?

    A possible Nortel/Alcatel combination has also been making the rounds. ("Nalcatel" has an interesting ring to it, doesn't it?) This rumor is the most vague and unbelievable of them all. It's a combination so strange and awkward that Leonard Nimoy is rumored to be looking into it. The deal killer might be product overlap – or perhaps a terrible mismatching of French and Canadian accents. On the upside: Nortel's pension issues are not as spooky as Lucent's.

  • Huawei/Whomever
    Just today, the China Daily, quoted a Huawei exec as saying the company has been talking to Lucent and Nortel (see Report: Huawei Talking to Lucent, Nortel). I'm sure these companies must have talked at some point, but the form any such deal would take is unknown. Would Lucent and Nortel really want to resell Huawei gear to their solid, North American RBOC accounts? A merger seems unlikely. At any rate, it's clear that managing relationships with Huawei will be one of the trickiest propositions for all of the equipment providers in 2005.

The same question dogs all these deals: How do they make money for shareholders? In the case of Lucent, Nortel, and Alcatel, you are presented with the unpleasant idea of a giant restructuring, golden parachutes, special charges, and massive labor force reduction. In the end, would such an excercise improve margins or competitive positioning? If you have solid relationships with leading incumbents and you've spent years slashing the workforce, it may make more sense to wait a bit longer and feel things out.

To Wall Street veterans, the talk of megamergers brings back many bad memories of the Hewlett-Packard/Compaq merger, whose outcome took years to unravel – and which didn't exactly prove to be a launching pad for shareholder value.

The bottom line is that the telecom equipment sector remains under severe margin pressure, much of which is coming from overseas forces and so can't be alleviated by a merger of Western partners. Think about it: If service providers are asking you to bring your margins down because China could supply gear at much cheaper prices, how does merging with a Western company help you?

This means that everybody will be in for a long painful slog in 2005 in an effort to figure out how, and when, this inevitable consolidation will occur – and what to do about those eroding profit margins.

It may take a stronger spark to make them happen: A big new revenue uptick in telecom land; some larger capital-spending deals; an explosion of IPTV; or some more pressure from the service providers to make deals happen for integration and service reasons. In short: There's no rush.

Or maybe these deals will be aided by this column. By publishing that they can't be imminent, surely we've just sped them up (see 2005 Un-Predictions).

— R. Scott Raynovich, US Editor, Light Reading

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