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Nortel's $1 Billion Pipe Dream

Light Reading
News Analysis
Light Reading
10/18/2000

Nortel Networks Corp.'s (NYSE/Toronto: NT) latest deal proves that it is still king of optical networking -- or should that be "king of optical financing"?

Late Tuesday, the company announced that it had sealed a $1 billion, four-year contract with greenfield carrier Aerie Networks for deployment of its long-haul optical gear in the provider’s 20,000-mile nationwide broadband network.

They're big numbers -- and they raise concerns about financing for such a deal. Nortel is providing up to 50 percent of it, but questions linger about how Aerie, a startup, is going to raise the rest of the money in a financial environment that is now skeptical of large-scale telecommunications projects.

“The announcement has a fair amount of fluff to it,” contends Fred Wang, general partner at Trinity Ventures. “It doesn’t really hurt Nortel to make an announcement like this. If [Aerie] can’t raise the rest of the equity [Nortel] might have a little egg on their face, but that’s about it.”

The project itself is huge. Using products from Nortel’s Optera portfolio, which includes the Optera Long Haul and Optera Connect DX and HDX Connection Managers, Aerie plans to build a network joining 194 U.S. cities over 8.9 million fiber miles. This will enable Aerie to provide bandwidth and services to carriers, content and application service providers, local access and metropolitan area network providers, and emerging intercity backbone providers.

Aerie began raising money last year, securing $10 million in its angel round from VantagePoint Venture Partners in September of 1999. Last spring it exchanged 30 percent of the company for another $150 million from 12 utility companies, which also granted rights of way along their pipelines.

The company recently secured $100 million in the first part of its C round of funding, giving the company a valuation of $500 million, according to Mort Aaronson, president and COO of Aerie. The second part of the round, which will be closing within the next few weeks, will add more cash to the provider’s bankroll. All told, the company is sitting on $260 million in cash with more cash to come. Add to that the agreement with Nortel, which gives them up to $500 million to spend on equipment as well as construction of the network, and the company has $760 million in financing on the books.

While most analysts agree that Nortel is a leading player in optical long-haul transport equipment, the vendor's willingness and ability to offer financing clearly had something to do with their winning the contract.

“Absolutely, you bet it had something to do with it,” says Paul Silverstein, senior analyst with Robertson Stephens “When you’re dealing with Ciena [Nasdaq: CIEN] that is a whole different ball of wax, and Lucent [NYSE: LU] is completely out of the game.”

Ciena, which has a long-haul product popular among carriers, doesn’t typically dish out financing. In fact, it's larger companies with rich cash positions, such as as Nortel and Cisco Systems Inc. (Nasdaq: CSCO), that are in a position to use financing to win deals.

(Aerie has also secured an exclusive contract for fiber from Corning Inc. (NYSE: GLW), worth in excess of $1 billion over four years. But no joint financing arrangements were included in that deal.)

Aaronson denies that Nortel’s deep pockets had anything to do with the decision to go with their gear. “Every vendor offered the same financing," he says. "Each one was equally aggressive. Nortel financing helps, but its not the only way."

The questions about Aerie's finanicial position make it difficult to evaluate the long-term impact for Nortel. But if Aerie prospers, it could turn into a viable revenue stream.

“In the near term this is basically a non-event,” says Silverstein. “But as Aerie shows that it has secured other financing, and as long as Nortel continues to execute well, this could be great incremental revenue for Nortel.”

Aerie has started laying fiber this month, concentrating first on connecting Houston with Chicago and New York with Washington, D.C. The provider expects to begin deploying the Nortel gear by the end of Q1 2001 with a rampup in deployment starting by midyear.

Nortel’s stock price fell $3.19 (4 percent) to $60.81 a share in midday trading.

-- Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com

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