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Nortel Buys: Reaping the Whirlwind?

When Nortel Networks Corp. (NYSE/Toronto: NT) updated its fourth-quarter guidance last week, it cited acquisition-related costs and goodwill writeoffs as key to ongoing per-share losses (see Nortel: The Bad News is Good).

From the goodwill writeoffs, it looks like the company will be paying for its past startup spending spree. Four of Nortel’s acquisitions seem to have been especially problematic. The company wrote down $12.4 billion in the second quarter, for instance, which it said was "primarily related to the goodwill associated with the acquisitions of Alteon, Xros, and Qtera within Network Infrastructure and the acquisition of the 980 NPLC Business within Photonics Components."

Table 1: Not the Fab Four
Acquired company Date acquired Price paid % of product complete Expected cost to complete product Expected revenues
Alteon WebSystems Inc. 5-Oct-00 $7.8 B 100% $1.1 M Began 2Q01
JDS Uniphase 980-namometer pump laser subsidiary 13-Feb-00 $2.5 B, with $500 M due 2003 10% $10 M 1Q03
Qtera Corp. 28-Jan-00 $3.25 B 56% $15.8 M Began 2Q01
Xros Inc. 2-Jun-00 $3.25 B 65% $8.8 M 1H02
Source: Nortel SEC filings

Since goodwill represents the premium a company pays for an acquisition, this means Nortel hasn't gotten its money's worth from these particular properties -- at least not yet.

This is no surprise to anyone who's been tracking the optical networking industry. "Nortel was one of the more aggressive buyers during the boom, so it stands to reason they may have to reevaluate some decisions," says Rick Schafer of CIBC World Markets.

Flush with success, the company's acquisition strategy in 2000 and early 2001 was aimed at bringing still greater wins: "You paid to play. Companies paid for what they didn't want to develop in-house," Schafer says.

Unfortunately, it looks like Nortel's biggest bets didn't pan out as hoped. In all, the company shelled out the biggest bucks -- over $16 billion -- on the four purchases that turned out to be most troublesome later on.

Ironically, these four acquisitions were supposed to be the most strategic: Alteon featured a load-balancing switch; the Zurich-based 980nm pump laser business of JDS Uniphase Inc. (Nasdaq: JDSU; Toronto: JDU) was meant to give Nortel a key means of creating its own optical subsystems; Qtera made ultra-long-haul optical transmission systems; and Xros's optical crossconnect was earmarked to become Nortel's photonic switch.

What went wrong? In hindsight, it’s easy to blame the industry slowdown across the board. And indeed, analysts say that's appropriate in each instance. But each property appears to have its own problems too:

  • Alteon: Critics said from the start that Nortel paid too high a price for what it was receiving (see Nortel Buys Alteon for Big Bucks ). Even though Alteon’s load-balancing and traffic management switch has been successfully blended into Nortel’s product lineup, it’s still apparently not justifying its high price tag.

  • Qtera: Nortel says that, like Alteon, this property has been successfully integrated into Nortel’s product line, although the cost to do so has been higher than the other writedown companies. Word on the Street is that the product is one of Nortel's biggest disappointments. Originally earmarked to compete with gear from Corvis Corp. (Nasdaq: CORV), Qtera's technology turned out to have problems, and the long-haul downturn killed hopes of making it even a "me too" offering. Some evidence that Qtera's performance was a downer for Nortel is given in SEC filings. Those indicate that in June 2001, the acquisition had failed to meet specific business performance objectives that would have resulted in payouts to former stakeholders.

  • Xros: This represents a problem for Nortel. Not only has the market moved away from photonic switches (see No Riches From Optical Switches ), it looks like Xros's technology itself had some key drawbacks. For one thing, it was based on 3D MEMS, a type of photonic component that has gone from hot to cold and is perceived as difficult to make (see 2001 Top Ten: Components). Xros also has suffered from the setback in demand for long-haul products.

  • JDSU's pump laser business: Although considered a hot pick at the time of its acquisition, the Zurich-based pump laser business Nortel acquired from JDSU early in 2001 has turned out to be something of a white elephant (see Nortel to Buy Swiss JDSU Plant). Not only has the market dropped considerably, but Nortel has inherited some costly legal proceedings resulting from lawsuits by disgruntled JDSU shareholders.

    Still, it must be recalled that at one time, JDSU's business was one of the two biggest in the world (along with SDL Inc., which was implicated in part of the goodwill writedowns taken by JDSU earlier this year -- see JDSU's Acquisition Hangover). Also, pump lasers are the basic requirements for optical amplifiers. As the market returns and inventory demand is renewed, it's likely there could be some considerable life ahead for this acquisition.

Investors may never know the extent to which some of Nortel's acquisitions were really blended into its product line. Nortel isn't required by law to disclose information at that granular a level.

In any case, the upcoming year could hold some surprises. Nortel has made it clear that in its ongoing efforts to regroup, whatever isn't paying off will be reconsidered in terms of its ultimate use to the company. What's more, in recent financial reports, the company has referred cryptically to properties earmarked for divestiture, without giving specifics. It's not inconceivable that some of last year's best ideas could wind up on the auction block.

— Mary Jander, Senior Editor, Light Reading
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self 12/4/2012 | 11:07:08 PM
re: Nortel Buys: Reaping the Whirlwind? to note that Nortel listed the Xros/Optera PX as being 65% complete in its 2000 10-K and in its Q1, Q2, and Q3 2001 10-Q's.
switchrus 12/4/2012 | 11:07:05 PM
re: Nortel Buys: Reaping the Whirlwind? "MEMS a fad?

what do u guys think?"

Not a fad IMHO, but for now the promise of all optical switching requiring the number of ports that a 3D MEMS is supposed to offer is quite a ways off.

2D MEMS are available now, and being used in small port count applications. When the rest of the GǣglueGǥ needed to build a true OOO switch becomes real, then maybe some demand for large port count devices will start to materialize. GǣGlueGǥ for building OOOGs include some sort of wavelength conversion process, along with some sort of low cost distributed amplification to overcome switching losses.
skywalker 12/4/2012 | 11:07:05 PM
re: Nortel Buys: Reaping the Whirlwind?
what do u guys think?

i'm a mems person myself.
though i don't think much of it,
i PARTIALLY agree to the quote.
edgecore 12/4/2012 | 11:07:03 PM
re: Nortel Buys: Reaping the Whirlwind?
What is the difference, where are 2D best suited, and 3D?


lame_duck 12/4/2012 | 11:07:02 PM
re: Nortel Buys: Reaping the Whirlwind? MEMS has been used for a variety of applications during the past 30 years but despite a few relatively successful commercial applications (pressure sensors, accelerometers) it never found a killer ap. Its use in optical switching had that promise but, indeed, it was just a fad because when the smoke cleared those that bought into the hype couldn't really figure out how these mirrors were going to increase earnings. Now everybody has a MEMS switch because, well, . . . all the other guys had one and no one wanted to be left out. Very unfortunate for the MEMS industry.

Despite all that MEMS technology really isn't a fad nor is it dead albeit perhaps a tad humbled. MEMS continues to be a player in a wide range of industries and there are even companies out there doing MEMS for telecom components - although not so many any more for optical switching.
edgecore 12/4/2012 | 11:07:02 PM
re: Nortel Buys: Reaping the Whirlwind? Merci mon ami!
Belzebutt 12/4/2012 | 11:07:02 PM
re: Nortel Buys: Reaping the Whirlwind? What is the difference, where are 2D best suited, and 3D?

skywalker 12/4/2012 | 11:06:56 PM
re: Nortel Buys: Reaping the Whirlwind?
i know there's been plenty of so called market forecasts for those mems products.
but most of them seem to end up as some fancy forecasts, just good enough to be used in deluding most everyone if necessary.
can someone suggest any trust worthy and detailed information on the optical switch market.
tachit 12/4/2012 | 11:06:55 PM
re: Nortel Buys: Reaping the Whirlwind? Hey Mems fans:

Check out startup Network Photonics; though I don't know much about MEMS, it seems they have a promising solution to most MEMS problems with their new optical switch. Seems to remove all the complexity of previous MEMS designs, and improve on reliability. If it works, could be killer.
5514DD 12/4/2012 | 11:06:49 PM
re: Nortel Buys: Reaping the Whirlwind? Excuse my ignorance, but is it possible to do wavelength conversion optically, without some sort of OEO conversion? If so, can anyone describe the technology?


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