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Nortel buys Bay for $9 billion

Nortel buys Bay Networks for $9 billion in what could be the first of several mergers between telecommunication equipment companies and data networking equipment makers.

    Canadian telecommunications firm Northern Telecom bought its way into the data networking market with the $9.1 billion acquisition of Bay Networks, catapulting the duo to the forefront of a converging marketplace.

    Under terms of the merger agreement, Bay shareholders will receive .60 of a Nortel share for each share of the company, representing a price per share for Bay of $38.21, based on Friday's closing price. At the close of the transaction Bay shareholders will own approximately 21 percent of Nortel.

    The announcement this morning that Nortel was making a bid for the struggling Bay was not entirely unexpected. Santa Clara, California-based Bay has fought to hold on in a market dominated by giant Cisco Systems.

    "We could see a major change coming in our industry," said John Roth, president and chief executive of Nortel. "This merger of Nortel and Bay is really a creation that is the first of its kind."

    Rumors have been tossed around the past week that a deal was imminent for Bay to be bought by a telecommunications player as voice and data networking converge into a single entity. The deal is part of a larger confluence surrounding the dominant transmission protocol for the Net--IP, for Internet Protocol--that is likely to eventually supply the means to send voice, video, and data traffic to its destination using a single connection, obviating the need for separate networks.

    Bay makes a variety of networking devices that are typically placed in corporate networks while Nortel, with $16 billion in revenue for its most recent fiscal year, focuses on building telecommunications networks, providing a different set of voice-based hardware.

    "We know going forward voice is data--there's new industry being created," said David House, chairman, president, and chief executive of Bay.

    Observers said the acquisition is sure to launch a wave of mergers between telecommunication equipment companies and data networking equipment makers as the two sides consolidate to fight for the same territory.

    Bay's stock was up on news of the deal while Nortel was down significantly, reflecting the perception in some circles of the financial community that the merger could be a drag on the telecommunications giant, given Bay's recent fiscal woes.

    The deal also offers further proof that smaller data-based players will need to make deals of their own or risk irrelevancy in a rapidly evolving market.

    "Bay was not survivable as a standalone company," said Tom Nolle, president of the Cimi Corporation, a Voorhees, New Jersey-based consultancy. "In today's service market you have to be a big carrier provider to have the margins to survive. Bay was not quite big enough to be a full service company and too big to be a niche player. Someone acquiring it was a done deal."

    Under the terms of the acquisition, Bay Networks will continue to operate as a wholly owned subsidiary of the Toronto, Canada-based Nortel, retaining its own brand, according to House.

    Nortel expects to issue approximately 134 million common shares. The boards of directors of the two companies have approved the transaction. Roth said the merger would likely be "dilutive" through the rest of Nortel's 1998 fiscal year, and "accretive" in 1999.

    Nortel's enterprise data networks business will be integrated with Bay Networks' operations. Roth will remain chief executive officer and a director of the corporation. House will become president of Nortel and will be appointed to Nortel's board.

    House, who joined the company in October 1996, is entitled to an accelerated vesting of his options when there is a change of ownership in the company, according to Bay Network's proxy filing. But, according to the proxy, he had no options to exercise as of June 30 last year.

    House, who will become president of Nortel, may never collect on his golden parachute from Bay. His employment agreement called for the CEO to receive 12 months' base pay, all of his target bonus, an additional bonus equal to a percentage of his target bonus, and health benefits of up to one year should he either be involuntarily terminated or terminate his employment with the company for "good reason."

    Under his 1997 agreement, House was to receive a minimum base salary of $500,000 and a bonus of up to $1 million, depending on whether he hit his performance targets.

    Doug Friske, an executive compensation specialist with Towers Perrin said that, traditionally, companies have vested all options upon a change of control and that a new employment contract is usually drafted for executives who are retained after a merger or acquisition. The golden parachutes usually don't kick in for CEOs until a merger has been completed and the executive is terminated, or leaves, he added.

    The transaction is expected to close late in the third quarter of 1998, pending stockholder and regulatory approval.

    Bay and other data players, such as Cabletron Systems and 3Com, have felt the effects of a tepid market in recent quarters. Only Cisco has been relatively immune, distancing itself from the pack in several markets.

    Looming on the horizon for all these companies is the increased interest in data-based networking from the likes of Lucent Technologies, a firm that has dipped into its pocketbook for a variety of data equipment in recent months. That same interest likely drove Nortel to make its play for Bay.

    "It's bigger is better," noted Craig Johnson, principal with market watcher the Pita Group, of the current industry trend.

    Some analysts observed that the pace of convergence between the voice and data worlds means that Bay and Nortel will have to merge efficiently or risk becoming a follower in the market.

    "These guys need to execute fairly quickly," said Michael Duran, analyst with Lazard Freres & Company. "To lead it, they have to get their act together fairly fast."

    Executives from both firms said there would be few, if any, layoffs due to the merger, given each firm's market focus. "I don't think you'll see any significant reductions because we don't have much overlap," House said. "Together we can really build on the synergy."