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News article received Sunday, October 04, 1998 10:56:26 AM EST
Brave New World,Brave New Vendors -- The new public network has triggered a
mad scramble among vendors to grab a good position in tomorrow's markets.
Merger madness is the only order of the day.
Oct. 04, 1998 (DAC - CMP via COMTEX) -- The new public network may take a few years to arrive, but
network architects are already starting to feel its impact. Vendors of internetworking and telecom
gear-desperate to put together product portfolios that span voice and data on public and private nets-are
snapping up startups and sizing up potential megamergers. Northern Telecom Ltd. (Nortel, Mississauga,
Ontario) recently shelled out $7 billion for Bay Networks Inc. (Santa Clara, Calif.). Now Lucent Technologies
Inc. (Murray Hill, N.J.), Ericsson Telecom AB (Stockholm, Sweden), and Siemens AG (Munich) are on the
prowl, and the stock prices of possible takeover targets like Ascend Communications Inc. (Alameda, Calif.)
and 3Com Corp. (Santa Clara, Calif.) have skyrocketed.
Forget Wall Street, what does it mean to corporate networkers? More uncertainty. There's no telling which
megamergers will succeed or go sour-or even which vendors will be around after the millennium.
"Look at how a big name like Pan Am disappeared during airline industry consolidation," says Bert Whyte,
president of Advanced Computer Communications Corp. (ACC, Santa Barbara, Calif.). "Users need to ask
themselves whether their vendors might go the same way."
It's equally tough to predict which products will be discontinued or supported as an afterthought.
So what's the best survival strategy? Start by reviewing recent acquisitions to see who's ahead and who's
bringing up the rear. Then try to get a feel for possible get-togethers. Winning mergers will likely involve big
players in the enterprise and the telecom markets-ones with complementary strengths in voice and data.
They'll also need global distribution channels and in-house expertise in everything from IP to WDM
(wavelength-division multiplexing) to SS7 (Signaling System No. 7).
Expert opinion also can be a good guide. Industry analysts have the best idea of who will climb into-and out
of-bed with whom. To make it easy to track these romantic encounters, Data Comm has gotten some of
brightest and the best to share their knowledge. And don't discount something as simple as stock prices.
Vendors that take a sudden plunge can go from being buyers to being targets in a big hurry.
While they're working the numbers net managers also need to consider what supervendors can do for
them-or to them. For instance, if PBX and networking manufacturers get the urge to merge, the new players
might actually implement voice over IP (VOIP), rather than arguing about whose job it is. Then again,
megavendors raise the risk of being locked in to single suppliers and proprietary technology.
"We're already living in that world," says Allen Valek, Latin American IT manager for Cargill Inc.
(Minneapolis). He points out that Cisco already has the router market locked up and Microsoft Corp.
(Redmond, Wash.) dominates the desktop.
Is it going to be a hassle? Undoubtedly. Net managers wondering about the payoff should keep something
else in mind. Getting smart about mergers and acquisitions is a great way for them to supercharge their
stock portfolios.
Shop Till You Drop
Buying startups is the simplest way for vendors to ensure they're ready to play on the new public network. That's a time-honored
tradition in the networking industry, which is one of the reasons those vendors have something of an edge (see Table 1).
Consider Cisco; it's bought everything except routing-snapping up eight startups in the past year. Key purchases for the new public
net: Ardent Communications Corp. (San Jose, Calif.), which cost $156 million and brought integrated access devices (IADs); Class
Data Systems Inc. (Cupertino, Calif.), which went for $50 million and brought policy-based routing; and Lightspeed International Inc.
(Sterling, Va.), which cost $160 million and meant SS7 expertise.
But not every networking vendor is as ambitious or as acquisitive as Cisco. 3Com is focusing on the edge of the network. That's
understandable, since one-third of all network connections worldwide use its adapters, modems, or other devices, according to Donald
Mulder, vice president of strategic alliances and planning. Ascend is carving out a niche in Internet backbone gear, thanks to its
acquisitions of Cascade Communications Corp. (Westford, Mass.), a WAN switch vendor, and Netstar Inc. (Minneapolis), one of the first
developers of a big backbone router.
Newbridge Networks Corp. (Kanata, Ontario) takes a different tack. It establishes "affiliates" to develop new products. The vendor
typically takes a one-third stake; another third is owned by senior staff, while entrepreneurs hold the remaining shares.
Newbridge is the exception. Overall, the relentless pace of development has ended up creating a culture in which startups are
launched in hopes of selling them to big vendors.
Telecom Reform
Telecom equipment vendors have been slower to embrace startup insanity, traditionally preferring to build the technologies they
need. That's starting to change, and in a big way.
"Almost every call I get these days is from a startup that's focusing on the service provider space," says Sheryl Schultz, president of
SRS Associates (Natick, Mass.), a PR consultancy specializing in startups.
Some of those startups are being sold for staggering sums. Lucent paid $1 billion for Yurie Systems Inc. (Landover, Md.) and its ATM
access gear. Nortel plunked down $305 million for Aptis Communications (Chelmsford, Mass.) and its next-generation remote access
concentrator.
European vendors still lag behind their U.S. counterparts. Ericsson just recently agreed to buy Newbridge affiliate ACC, which will
give it a remote access concentrator and a range of routers. Siemens, meanwhile, is looking for U.S. startups.
Alcatel (Paris) seems to be in denial. It says that plain old telephone services (POTS)-mainly in developing countries-is all it needs for
the foreseeable future. "The driving force is POTS, POTS, POTS," says Peter Radley, director of marketing and business
development. With this in mind, Alcatel recently acquired DSC Communications Corp. (Dallas), a large vendor of POTS equipment.
Neil Ricard, U.K. research director of The Gartner Group (Stamford, Conn.) says that's like "creating the biggest mainframe vendor in
the world, right when everybody's stopping buying mainframes."
Together At Last
Buying startups may get vendors hot new technologies, but it can't give them market presence and global distribution. That's where
megamergers come in. Nortel's buyout of Bay, for instance, is supposed to give it instant credibility with corporate networkers,
especially those struggling to roll out VOIP on their intranets.
Nortel also gets Bay's IP expertise, along with its LAN hubs and switches-a good match for the telecom switch supplier's WAN data
line. But gaps remain. Nortel has yet to show a big box for ATM (asynchronous transfer mode) backbones (it's under development),
and Bay still lacks a big backbone router. Nortel's 20 percent stake in Avici Systems Inc. (Chelmsford, Mass.) is supposed to remedy
this.
The Bay-Nortel deal also is likely to push other big PBX and networking vendors into pairing off. Lucent is more than ready; it's eager
to catch up with Nortel and get on par with Cisco. Until now, however, the terms of its separation agreement with AT&T have
prevented it from issuing new shares to finance acquisitions. That restriction expires this month, and "things are going to go really
crazy," says Gary J. Bowen, an independent investor and business advisor.
Buying a PBX vendor is on Cisco's "route plan," admits Mike Zolpi, vice president of business development. The vendor has discussed
and dismissed mergers with Lucent and Nortel, but that was before the Nortel-Bay alliance. Cisco might buy Nortel outright. Or Lucent
and Cisco could decide they were made for each other, in the mother of all megamergers.
Where does that leave other makers of public network switches? Sources close to Siemens say the company is divided. The old
school, which still holds sway, says there are plenty of profits in POTs. The young Turks argue that it's now or never for the new public
net. Ericsson, meanwhile, thinks big acquisitions are too risky. Its policy is to stick with smaller targets to plug its product portfolio.
The Match Game
Pairing up strengths and weaknesses for other vendors can yield some clues about possible mergers and acquisitions. Data Comm has
done a lot of the legwork here, rating vendors as strong in a particular technology partly based on market share, using statistics chiefly
from the Dell'Oro Group (Portola Valley, Calif.). In some cases, the segment itself is immature or the vendors that have products are
themselves takeover targets.
Service-level management is an example of an immature market. Cisco is likely to emerge as a leader, since it controls some of the
key standards work being done on IP QOS (quality of service). But that work is still at an early stage, and the technology itself is likely
to be integrated across a variety of products, from IADs to backbone routers and ATM switches.
WDM is a market that's weak because the top players are likely to be picked off by other vendors. Leader Ciena Corp. (Linthicum, Md.)
until recently was the target of a possible takeover by Tellabs Operations Inc. (Lisle, Ill.). It's probably on Cisco's shopping list now.
The same goes for the security segment and its leaders, Check Point Software Technologies Inc. (Redwood City, Calif.) and Raptor
Systems Inc. (Waltham, Mass.).
How does all this help corporate networkers peer into the future? Look for marriages between leading vendors that complement each
other's strengths and compensate for each other's weaknesses-without wasting resources on redundant products, services, or expertise.
Knowledge Workers
Data Comm also asked its jury of expert analysts and venture capitalists to cogitate on some possible pairings (see "The Jury Is In").
They were asked to rate the likelihood of these get-togethers on a scale of 1 to 5, with 1 being very unlikely and 5 being very likely.
Here's what they had to say:
- Lucent buys 3Com
Despite an average rating of 1.33, this deal is much favored by Nick Lippis, Data Comm contributing editor and president of Strategic
Networks (Rockland, Mass.). "Lucent is strong in the core. 3Com is strong on the edge. Together they would have a story that no one
could come close to."
Still, there would be some product duplication, such as RASs (remote access servers). Further, Lucent's Packet Star, its recently
launched monster IP switch, is still an unknown, and the vendor gets its ATM backbone switch by reselling Apex from General
Datacomm Corp. (GDC, Middlebury, Conn.) Buying 3Com and GDC could be the answer.
3Com would give Lucent a global distribution channel, a good move for this U.S.-centric outfit. It also might speed further
acquisitions: Worldwide distribution would make it easier for the vendor to ramp up sales of products it picks up from startups.
- Lucent buys Ascend
The Data Comm dozen liked this deal, which at 3.83 achieved the highest average score. "Ascend is the crown jewel of acquisition
targets," says Bowen. "Only two vendors get to sit at the table with Uunet: Ascend and Cisco."
The deal would certainly give Lucent a strong position in WAN gear; it would also duplicate some recent developments and
acquisitions-like Packet Star and the remote access concentrator it got with Livingston Enterprises Inc. (Pleasanton, Calif.). The real
problem, however, is that Ascend isn't a player in the LAN market, which would leave Lucent with a big hole to fill via another
acquisition.
- Lucent buys Cabletron
This move garnered an average score of 2.67. For Lippis, it's the obvious complement to an Ascend acquisition. However, it's missing
the global distribution that a 3Com buyout would provide. And Cabletron has a much smaller share of the enterprise market.
- Siemens buys Newbridge
Another favorite with the jury, with an average score of 3.25. The duo already have a partnership that has developed a range of ATM
switches, which both vendors sell. They're also working with 3Com on IP-over-ATM developments.
Newbridge already has a beachhead in the service provider market and a strong U.S. presence (which Siemens needs). But it doesn't
have a strong presence on the LAN, so Siemens won't get much in the way of VOIP technology for its current PBX customers. And
many of Newbridge's offerings for the new public network belong to its affiliates, which complicates things. What's more, its decision to
sell off ACC to Ericsson suggests that the Siemens buyout is wishful thinking.
- Siemens buys 3Com
With an average score of 2.75, this deal is a maybe-yes, maybe-no proposition. The pairing would give Siemens a way into the
enterprise and make it a big player in the U.S., where the new public net is likely to evolve fastest. A three-way merger of
Siemens-3Com-Newbridge would be even better, although it wouldn't have the clout of a Lucent-Ascend-Cabletron combo in the ISP
(Internet service provider) arena. It's time for Siemens to make a move, though; its future hangs in the balance.
- Ericsson buys Ascend
With an average score of 2.83, this deal is definitely on the jury's radar screen. Actually, many analysts thought Ericsson would buy
Bay-until Nortel got there first. Now the attention is on Ascend, because the two vendors' product lines complement each other well.
But if an Ascend acquisition were in the works, why is Ericsson buying ACC? ACC's Tigris remote access concentrator is a direct
competitor to Ascend's TNT. It's much more important for Ericsson to buy a strong LAN vendor like 3Com, which would get it into the
enterprise and increase its U.S. presence.
Bulls and Bears
Corporate networkers trying to assess potential acquisitions should consult a very useful tool: a stock ticker. Shareholder confidence is
key to launching huge takeovers, and that's reflected in stock prices. The higher they are, the more likely vendors will be to pull the
deal off.
To clinch the Bay buyout, for example, Nortel issued 134 million new shares, swapping 6 for every 10 Bay shares held by investors. In
other words, Nortel didn't pay a bean for Bay; its shareholders picked up the bill in a dilution of their stock.
Holders of Bay's stock wouldn't have accepted the deal if Nortel's price had gone down much after the terms had already been agreed
upon. So Nortel had to convince its own investors that the acquisition would increase profits. If stockholders weren't with the program,
they might have sold off shares, driving prices down-possibly to the point at which the deal would have fallen apart.
That's pretty much what happened last summer with Tellabs' proposed takeover of Ciena. Initially, Tellabs offered a one-for-one stock
swap, valuing the deal at $7.1 billion. Then Ciena's share price plunged after AT&T decided against deploying the vendor's
equipment. As a result, the whole deal was called off.
So how can corporate networkers get a good read on which deals are likely to go south? For starters, look at the buyer's
profit-to-earnings (P/E) ratio-the share price divided by the projected profit per share. A high (inflated) P/E ratio can be good news for
the vendor because it gives them purchasing power. It also can be a bad sign, since the higher the P/E, the less stable the stock price;
thus, the more likely that the deal will fall through because of jittery investors. "Lucent could see their stock hammered if one of their
acquisitions goes wrong," says Lippis.
Bear in mind that P/E ratios aren't failsafe indicators. Share prices can skyrocket because of takeover speculations. 3Com's P/E ratio,
for instance, is roughly five times Cisco's, partly because of speculation that it might be a takeover target.
One way of avoiding this complication is to use a different ratio to see if deals could go sour, one that compares a company's market
capitalization (the total number of shares multiplied by their price) with its revenues (see Figure 1). Cisco's relatively high market cap
indicates that its shareholders are used to coming out ahead on acquisitions. That gives the vendor a lot of credibility chips to cash in
if it decides to pursue a big buyout, like Nortel.
Culture Club
All the money in the world is still no guarantee that a megamerger will actually work. When East Coast Wellfleet and West Coast
Synoptics merged to form Bay, the new company ran into all sorts of culture clashes. There's room for even more misunderstanding
when networking and telecom vendors hook up, particularly ones based in the U.S. and Europe.
"There'll be dancing in the streets at Cisco if Siemens or Ericsson takes over 3Com," says Lippis. "It would sink them."
Ironically, Bay tried to integrate its diverse staffs into a single company, recalls Bowen, a Wellfleet founder who lived through the
Synoptics merger. It didn't work. When Bay bought Centillion, it went to the other extreme. Then-president and chief executive officer
Andy Ludwick told employees they couldn't visit Centillion without his personal permission. That helped hold down the clashes.
Nortel seems to be taking a middle road with its Bay buyout. Bay has become a division of Nortel and has absorbed its enterprise data
products. A new division, called Carrier Packet Networks, brings together Nortel and Bay businesses targeting the new public net.
David House, Bay's chief executive officer, has been made president of Nortel.
Lucent also has been nurturing key staff in its acquisitions. Yurie's chairman and chief executive officer Jeong Kim now heads up
Lucent's carrier data networking division. Menachem E. Abraham, the former president and chief executive officer of Prominet Corp.
(Westborough, Mass.), which Lucent picked up in December 1997, is now president of gigabit Ethernet switching products in Lucent's
data networking systems group. "If Siemens, Alcatel, and Ericsson are going to succeed with acquisitions, they'll have to take the
same approach," says Bowen.
The Vendor Agenda
At this point there's no stopping convergence or consolidation. Is the arrival of supervendors a good or bad thing for corporate
networkers?
Both, as it turns out. On the positive side, megamergers will simplify the buying process. "The fewer the suppliers the better, so long
as we still have competition in each category," says Nick White, head of technology and telecommunications at Unilever PLC
(London).
A single vendor supplying a complete solution also means network architects won't have to get so bogged down in planning,
designing, and building. And it shifts the risks onto the vendors.
Sounds great. And it could be for technologies like VOIP. Lucky net managers will see their current PBX and networking vendors meld
into a supervendor ready to do it all for them. Unlucky ones, however, will watch their vendors wind up in different camps. And they
could wind up caught between warring supervendors.
Corporate networkers could have more to worry about: Supervendors could signal the return of the bad old days, when vendors like
IBM locked in customers with proprietary technology. Actually, it could be worse: The lock-in could start inside the service provider's
network.
Sound like just another conspiracy theory? Consider: Competitive pressures are forcing carriers to use the latest technology, which is
often proprietary.
"We can't wait for standards anymore," says Fred Booman, director of networks for Unisource Carrier Services (Zurich, Switzerland), a
provider of wholesale voice and data that recently bought a multiservice ATM backbone from Lucent.
It gets worse. Vendors could work with carriers to lock in their joint corporate customers. It's a simple sell: Just point out all the benefits
that customers will get by standardizing on the same vendor their carrier is using. Cisco and its carrier partners, for instance, could trot
out the same old argument now used to sell IGRP (Interior Gateway Routing Protocol): Customers are free to stick to standards, but
they'd get more bang for the buck if they used Cisco's products everywhere.
Nortel already encourages its carrier customers to get locked in, rewarding those who do with early access to new technologies.
This isn't scare-mongering. "With voice over IP, we already have to go with certain ISPs," says a net manager at a major U.S. bank
who asked not to be identified. "It's not a problem yet, but I can see it becoming one."
Locking in will become even more appealing-and dangerous-once VPNs (virtual public networks) are rolled out over the new public
net. Customers will likely be offered incredible bargains-and services-if they go with a single operator. Trouble is, switching carriers
could mean disrupting all those services at the same time.
"I don't think the market will let it happen," says White. Then again, the market has let Cisco and Microsoft come to unprecedented
power. It may be the new public network, but net managers need to watch out for some old, familiar hassles.
-Peter Heywood is executive editor of Data Communications International and is based in London. His e-mail address is
pheywood@data.com.
---
Sidebar-
Capitalist Tools
Playing the stock market is a gamble, especially when it come to startups targeting the new public net. Play it safe and smart-and
check out these tips from venture capitalists.
Stick to a few companies with innovative technologies in emerging markets, like IADs (integrated access devices), service-level
management, or programmable switches.
Judge vendors by revenues and earnings momentum, not their P/E (profit/earnings) ratios, which can look alarmingly high but often
don't mean much in volatile markets.
Buy shares just after earnings are announced; prices often fall back when rumors of results exceeding expectations are put to rest.
Keep tabs on stock splits-rumored or announced. These usually push up prices significantly, since they indicate management
confidence. Could be a good time to sell.
Find out when company founders will be free to sell their stock. They often flood the market, driving prices down. Think about selling
before they do and buying shares back afterwards.
Don't bet on turnarounds. If something goes wrong once it often goes wrong again.
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