Nortel Optical Sweepstakes

 

Among those, the optical unit still figures prominently, although it has not gotten as much attention lately, given the predisposition of the press in covering the Ericsson/NSN bidding war followed by the RIM protests and Canadian Parliament special hearing. The optical portion of the MEN (Metro Ethernet Networks) segment for Nortel generated roughly $1.1 billion in 2008 and while it had declined to the third spot (behind Alcatel-Lucent and Huawei), that optical unit still held a steady 8% market share at the global level. 

 

Nortel had been the 800-pound gorilla in the past in the optical transport market, but the company struggled with increased competition and some execution issues such as the manufacturing transition to Flextronics, which impacted the lead times, stretching them out to 16 weeks, as they encountered difficulties in manufacturing. But over time those issues were resolved and Nortel still remains a force to be reckoned with in the long haul WDM market. 

 

In addition, the company also possesses a leading 40 Gig technology, which is can be an important trump card for a potential acquirer. According to RBC Capital Markets estimates, the Metro Ethernet 40G optical business is estimated to be approximately worth $1.7 billion in 2009. Nortel actively invested in this area, while other incumbent vendors opted to OEM 40G technology from a privately held vendor. Nortel had been keen on developing its 40G product line using a single wavelength approach, which is different than the 4x10G strategy being favored by vendors such as Infinera.

 

 

The list of vendors that could be eyeing Nortel’s optical business is long, and includes the likes of Ciena, Cisco, Ericsson, Fujitsu, Huawei, Infinera, Juniper, Nokia Siemens Networks (NSN) and Tellabs, among others. Given that Ericsson won the CDMA/LTE asset sale, we believe it is less likely to participate in the optical auction. Infinera might not have the necessary financial strength to make a solid bid, and Huawei would face a lot of scrutiny both in the US and Canada due to national security concerns of having traffic running over equipment acquired by the company. 

 

From the above list, Cisco, Fujitsu and Tellabs are a bit more of long shot contenders, but on the other hand, these challengers should not be readily dismissed. Cisco has a large cash balance, and some industry pundits could interpret John Chambers’ statement to explore “market adjacencies” as perhaps a signal of intent to bid on Nortel’s enterprise and perhaps even optical business. Fujitsu has a good North American presence, and could bolster its current 7% optical share with a potential purchase of Nortel’s optical unit to put more pressure on Alcatel-Lucent (20% share in Q1 2009) and Huawei (22% share in Q1 2009). Lastly, Tellabs could also emerge as a bidder, given the fact that there is less of an overlap with Nortel’s product lines and Tellabs’ ROADMs (Reconfigurable Optical Add-Drop Multiplexers) can complement nicely the Nortel portfolio. In addition, there could be synergies in areas such as wireless backhaul, FTTH and IPTV.

 

That leaves Ciena, Juniper and NSN as the most probable bidders. In the highly competitive optical market, Ciena is a small player compared to rivals like Alcatel-Lucent (ALU), Nortel, Huawei and Fujitsu. But unlike Infinera, Ciena has a better cash position, albeit also more debt. Making an expensive acquisition would lead to taking on more debt, a risky proposition in the current macro environment. But the possibility to gain more scale, market share and manage new accounts might make this a possibility worth considering. 

 

NSN would be able to absorb Nortel’s optical business with fewer difficulties, and the acquisition would be a bit of a “consolation prize” for the company, after losing the CDMA/LTE assets to Ericsson. More importantly, the purchase would enable NSN to augment its footprint here in North America, which traditionally was the Achilles’ heel for the company from a global revenue split perspective. 

 

Juniper is another good candidate, given the close ties it has with Nortel. George Riedel, the current CSO (Chief Strategy Officer) for Nortel was previously responsible for strategy and corporate development at Juniper prior to joining Nortel in 2006. Moreover, Lauren Flaherty, who is the current CMO (Chief Marketing Officer) at Juniper previously held this function at Nortel until last year. However, in the recent past, Juniper has acquired the reputation of not being particularly aggressive in bulking up.

 

 

Transport equipment utilizing wave division multiplexing (WDM) keeps on driving the optical market, as operators add capacity to their metro and long-haul networks. From the top ten players in the market, only Huawei and Alcatel-Lucent have managed to gain or hold share, while most of the other competitors have experienced consistent share declines. As Nortel unwinds its operations, the implication for these other vendors is clear: try to get bigger to fight the top two players (Huawei and Alcatel-Lucent). Most of these players either rely heavily on legacy products or have a narrow portfolio and as a result have low to mid single digit market share.

 

Achieving M&A synergies in the optical business has been a difficult objective from a historical perspective, particularly when the acquirer has a competing organic solution. This was certainly the case in the Alcatel-Lucent merger. The integration of the two companies was further exacerbated by key service provider customers demanding that the newly formed organization should support both the organic and the acquired product lines, a situation that is not very desired when conducting an M&A integration exercise.