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2HRS2GO: Why not Nortel-Alteon?

Nothing can warp perspective like Wall Street.

Nortel Networks (NYSE: NT) today announced a deal to buy Alteon Websystems (Nasdaq: ATON) for $7.8 billion in stock and no one on Wall Street seems to like it. NT shares dropped more than 7 percent following the announcement. ATON stock tumbled more than 10 percent.

I wouldn't be surprised if much of Nortel's drop stems from technical trading issues. After all, the Nasdaq Composite Index -- Nortel is on the NYSE, but the Nasdaq remains an accepted measure of sentiment regarding the overall tech sector -- is down more than 3 percent as this is being typed. Combine that generally negative tenor with the fact that buying Alteon would increase Nortel's shares outstanding by more than 3 percent, and you might have an explanation for NT's drop.

Can't fault the acquisition from a strategic standpoint. Alteon's line-up of switches specifically designed for delivering Web content and applications would seem to fit well with Nortel's line of network traffic gear. And Alteon's business isn't just promising, it's roaring now: the company more than quintupled First Call's consensus estimate in the fourth quarter and left analysts scrambling to update models that didn't predict profitability for Nortel for a couple of more quarters.

That recent performance sent shares of Alteon into orbit, including an all-time closing high of 158 3/8 on Monday. The stock had since fallen to slightly more than a dollar below the price offered by Nortel as of yesterday's close.

Some Alteon shareholders are now whining about not getting a premium. Those folks need to come back to Earth.

Nortel's offer, whether at yesterday's price of $144 per share or this afternoon's value of $134 and change, stands far above Alteon's value less than three weeks ago. Wall Street went crazy with ATON after the company's fourth quarter preannouncement, but the long term story for Alteon never changed.

Last year people bemoaned dot-com hype. Now the hysteria has simply moved to networking. And just as some people cried about "small" premiums for Web stocks that were inflated because of one rumor or positive report, Alteon stockholders are clamoring for more.

As if 73 times next year's estimated earnings isn't enough. How greedy can you get? Nortel's offer represents nearly an 80 percent premium from Alteon's first day closing price in September. Not many stocks can claim that kind of appreciation over the last 10 months.

And Alteon shareholders will get stock in a great company. The Nortel monster appears to hold an edge over chief rivals Lucent (NYSE: LU) and Cisco Systems (Nasdaq: CSCO) in carrier-class optical networking, at least for now. In the long run, which company do you think will be richly rewarded by Wall Street? A broad-based market leader like Nortel or a niche company like Alteon?

ATON shareholders might as well get some kind of reward now, although the ones who bought in recently might be annoyed. But people who buy at the top of a momentum wave create their own problems.

Other issues:

  • America Online (NYSE: AOL) and Worldcom (Nasdaq: WCOM).
  • Yesterday Worldcom blamed part of its disappointing revenue on unexpectedly low traffic from AOL. But that doesn't necessarily indicate a problem with AOL.

    An AOL spokesman declined to comment on Worldcom's assertion. Still, anyone who looks at AOL's traffic historically can see it usually dips during the summer, because people have lives.

    Perhaps more important this time around, America Online has aggressively negotiated prices with backbone providers. Backbone pricing in AOL's second quarter fell 8 percent sequentially, notes Abhishek Gami, Internet analyst with Willam Blair & Co. "They're very savvy buyers of bandwidth," Gami says.

    The analyst points to at least five backbone providers for AOL: Worldcom; PSINet; Global Crossing (Nasdaq: GBLX); a bit from Sprint (NYSE: FON); and the newest one, Level 3 Communications (Nasdaq: LVLT), which has been getting more of AOL's business, Gami says. "There are other low cost providers out there," he points out.

    Competition is always good for pricing, which is one reason why the U.S. Department of Justice and the European Union steamrolled the Worldcom-Sprint deal. On the other hand, it also shows Worldcom's supposed dominant position in Internet backbone might not be as strong as government regulators think, especially with more fiber coming online all over the world. Providers in Europe, Asia, Latin America and North America are all expanding their networks, and as ISPs and other carriers get bigger, they'll have more leverage to squeeze prices further.

    Worldcom, merger or no merger, isn't going to change that.>