Nortel May Be Paying a Parts Premium

Bookham Technology plc's (Nasdaq: BKHM; London: BHM) deal to buy the components division of Nortel Networks Corp. (NYSE/Toronto: NT) is looking even better these days, given an interesting pricing relationship.

Sources say Nortel sold the business to Bookham in 2000 with the agreement that it would continue to keep Bookham as a supplier and buy the components at fixed prices -- even though the market rate for optical components is dropping.

Nortel agreed to buy a fixed percentage of its components from Bookham for three years, with purchases guaranteed to total at least $120 million for the first 18 months (see Bookham Buys Nortel's Components Biz).

Other details of the contract haven't been revealed, and Nortel declined to comment for this story. But according to sources, part of the deal has Nortel paying fixed prices on certain parts, a deal that gets worse as component and module prices decline. "I think the spot price is below what those contracts dictate," says one analyst who requested anonymity.

This also implies that Bookham is collecting some revenues that will dry up when the prix-fixe contracts end, but that might not be cause for worry. "Nortel is buying more than the minimum dollar amount anyway, so [the revenues to Bookham] are not going to fall off a cliff," the analyst says.

Nortel accounted for 58 percent of Bookham's sales in the quarter ended Dec. 31 (see Bookham Cuts Loss in Q4). One source in the components industry notes that prices for some parts have dropped by half since Nortel signed with Bookham. But it's tricky to pin down a number, because prices can differ among similar varieties of a laser or PIN diode.

Analyst Jeff Montgomery with ElectroniCast Corp. notes that some long-haul component prices fell as much as 60 percent between 2000 and 2003. But most of that was in 2001 and 2002. "Particularly through 2002, a lot of folks were moving components at scrap value, almost, just moving them to get cash," Montgomery says. "The folks such as Nortel, Tellabs, and Alcatel building big boxes didn't sell many of them and didn't need many [of those components]."

While things were still bad in 2003, the price decline was probably more like 12 to 15 percent, Montgomery estimates. That's compared to a 10 percent decline in a typical year.

Even if the prices are high, Nortel might not be unhappy with the arrangement, as Bookham's products are a known quantity. "It may have as much to do with innovation, service, and reliability," says Tom Hausken, an analyst with Strategies Unlimited.

One of the sources noted the same kind of situation might exist between Avanex Corp. (Nasdaq: AVNX) and Alcatel. Avanex acquired the component divisions of both Alcatel and Corning in a deal that included a three-year purchasing commitment from Alcatel, among other concessions (see Avanex Deal Reshapes Sector and Avanex Buys Alcatel, Corning Divisions).

But Alcatel says that isn't the case. Avanex and Alcatel committed to a three-year supply agreement, but "the commitment to buy from Avanex does not mean the prices are frozen," an Alcatel spokesman says. He adds that prices are "negotiated on a regular basis."

— Craig Matsumoto, Senior Editor, Light Reading