Sorrento Networks Corp. (Nasdaq: FIBR) hopes to extend its DWDM customer reach by buying privately held LuxN Inc. in a transaction valued at about $17 million to $18 million (see Sorrento to Buy LuxN).

Sorrento hopes the deal will help it build up its market presence. Now, most of its revenues come from supplying metro-level DWDM to cable MSOs (multiservice operators) in North America. With LuxN, the company hopes to extend its capabilities to furnish access as well.

Sorrento's VP of sales and marketing, Mitch Truelock, hinted at the strategy on the company's June 9 earnings call, even though the buy was still in the works. According to SEC records, he told analysts: "Areas we're going to focus on... it's going to be the cable MSO market and being able to do, you know, some of their infrastructure, backbone deployment, as well as the video and [SAN] services that they're looking at rolling out." (Emphasis added.)

Cable MSOs in North America see data access services for residential and business customers as key to competing with ILECs (incumbent local exchange carriers). They're also keen to deploy wavelength services, and they need CWDM/DWDM technologies to do so (see Cox Makes Waves With Level 3). Thus, if Sorrento wants to keep pace with its chief customers, it needs to furnish as broad a range of goods as possible.

LuxN, which has long furnished enterprise CWDM and DWDM access, particularly for extending SAN (storage area network) services to corporate users, is a prime partner.

Terms of the agreement include two options for closing the deal, which Sorrento hopes will happen by August 8. According to CFO Joe Armstrong, LuxN shareholders can choose to get a share of the cash left in the company at closing or swap out their LuxN shares for Sorrento ones.

Currently, the deal would be about $17 million to $18 million in the first case, including the cash distribution. If shareholders opt to go for Sorrento shares, there could be a delay, since Sorrento can't sell more than 20 percent of its stock (roughly 1.8 million shares) in a merger without majority shareholder approval. Still, Armstrong says the deal could still close in August if a lot of shareholders opt for equity in Sorrento; the closing would have to be done in separate installments, however.

At the end of April 30, Sorrento had $8.8 million in cash and securities on hand. Revenues for the quarter were $7.9 million, down 7 percent sequentially. Its market cap is approximately $24.1 million.

The numbers seem small. But like other companies in the sector, both LuxN and Sorrento have fallen on hard times. Sorrento recently revamped its financial structure in a complicated but apparently sensible restructuring with creditors that took months to implement. It has resulted in a streamlined balance sheet (see Sorrento Launches Restructuring, Sorrento Restructuring OK'd, Marconi Launches Multiservice IP VPN, Nasdaq Panel Okays Sorrento).

Meanwhile, LuxN has maintained a quiet demeanor, with occasional news of contracts (see IP Networks Picks LuxN) and intermittent word of fresh layoffs (see Lights, Camera, Action!).

There are signs that the two companies, which have managed to hang onto modest market positions through the downturn, could stand stronger together than they do alone. Take the customer roster: Despite claiming more than 30 influential customers such as Cox Communications Inc. (NYSE: COX) and Deutsche Telekom AG (NYSE: DT), Sorrento relied on just five customers for 92 percent of its revenue last quarter. One of those accounted for 40 percent of sales.

Clearly, Sorrento's vulnerability to a handful of influential customers is reduced by acquiring some of LuxN's customers -- and vice versa. LuxN's roster includes a couple of plum accounts, like Time Warner Telecom Inc. (Nasdaq: TWTC), a strategic MSO for any vendor.

Bottom line? Two small but staunch downturn survivors are looking to join forces to make stronger MSO music together.

At least one analyst thinks the news is part of a trend. "The WDM segment needs consolidation," says Michael Howard, principal analyst and cofounder of Infonetics Research Inc. The market's growing: He predicts metro WDM sales worldwide will grow by over one third this year, totaling about $860 million. And there are plenty of players: Besides big vendors like Alcatel SA (NYSE: ALA; Paris: CGEP:PA), Ciena Corp. (Nasdaq: CIEN), Cisco Systems Inc. (Nasdaq: CSCO), Lucent Technologies Inc. (NYSE: LU), Nortel Networks Corp. (NYSE/Toronto: NT), and Siemens AG (NYSE: SI; Frankfurt: SIE) -- via its alliance with ADVA AG Optical Networking (Frankfurt: ADV) -- there's a slew of small but spunky fry, including Internet Photonics Inc., Lumentis AB, and Movaz Networks Inc.

Howard thinks it's possible that Sorrento's positioning itself as an acquirer: If the merger with LuxN works out, it may not be averse to munching on another startup, particularly if it comes with good customers, he notes.

Spokespeople for both Sorrento and LuxN say LuxN's Sunnyvale, Calif., office will remain open and its 70-odd employees will stay put -- for the time being, anyway. As the integration with Sorrento's 105-member workforce progresses, other decisions may prevail.

At press time, Sorrento shares were trading at $2.60, down $0.10 (3.70%).

— Mary Jander, Senior Editor, Light Reading