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Challenges ahead for Nortel-Bay combo

As the honeymoon comes to an end, analysts and industry observers question what the next year will bring for the marriage of telecommunications giant Nortel Networks and data networking player Bay Networks.

As the honeymoon comes to an end, analysts and industry observers question what the next year will bring for the marriage of telecommunications giant Nortel Networks and data networking player Bay Networks.

A year after its $6.7 billion Bay acquisition, Nortel has finally completed the integration of the two companies. Executives now say the firm is poised to become a powerhouse in the emerging convergence market that includes rivals Cisco Systems, Lucent Technologies, and others.

Before the deal, Bay was struggling as a solo data networking equipment maker, while Nortel, focused on telecommunications equipment, needed to get into the booming data market. Believing in the convergence revolution--combining voice and data over a single network--both firms needed a boost to reinvigorate their businesses.

"For our viability, we needed this merger," said Luc Roy, product marketing director for Nortel's enterprise networking systems and former Bay executive. "We were the No. 2 networking company and not winning the war."

Analysts say the companies were a perfect match, but point out that Bay's networking equipment line for businesses has yet to make a big impact on Nortel's bottom line.

"The Bay business has not grown and perhaps even declined," said Warburg Dillon Reed analyst John Wilson. "From that perspective, if you paid [nearly $7 billion] for a $2 billion company, that's a bad acquisition," he said.

But if the convergence market heats up and companies at large are convinced that the new networking products can work, Nortel should start seeing some serious return from its multibillion-dollar investment, analysts say.

"Bay establishes Northern Telecom as a data player in the important carrier business, said Wilson. "That gets them in the door and on the short list of every customer. Nortel will get action."

Convergence call
Nortel's Bay acquisition was the spark in the new market for converged network technologies. The merger spurred rivals Cisco and Lucent to respond with takeovers of their own. Lucent, for example, bought Ascend Communications and Excel Switching, among other networking firms.

Now that the dust has cleared from the flurry of merger activity, the biggest challenge for Nortel is marketing its services, according to Dataquest analyst John Armstrong. Although some say Nortel had previously been weak in this area, the company needs to shed its low-key demeanor to compete against established players like Cisco, as well as against hot start-ups like Juniper Networks.

"My concern for Nortel is in a market as dynamic and vociferous as this telecom market, [it] lacks a basic level of flamboyance," Armstrong said. "It's not the old voice game when they competed with stolid players like Lucent or Ericsson. They need to generate visibility."

Nortel has its work cut out as it takes on Cisco's marketing machine and the might of Lucent, some analysts say. "They have an overall marketing challenge ahead of them, to change from a pure technology selling company to a true marketing organization," said Craig Johnson, an analyst with the Pita Group.

Nortel stock chart "Marketing is what matters now. Given their history, they have to turn the company upside down to accomplish this," he added.

But executives from Nortel said the Bay acquisition raised its profile in the networking world. Based in Canada, the firm's presence in the United States often went unnoticed next to larger U.S.-based players.

"We had been in the United States, in Silicon Valley, for 26 years and were invisible. The merger made us instantly visible," said Rick Moran, Nortel's vice president of global enterprise marketing.

Nortel's Roy, a former Bay executive, said the two companies have meshed together peacefully and are now working together smoothly.

"You've got a mix of cultures, but in a positive way. We learn from each other," he said. "[Bay] wants to become like Nortel in terms of engineering and reliability of products, but at the same time, have the same aggressiveness and sense of urgency we've always had. As a whole, it's been positive."

Revenue questions
Bay's corporate business has remained fairly static with single-digit percentage growth, making about $2 billion in yearly revenue, Warburg's Wilson said. Nortel's total revenue is expected to jump 15 percent this fiscal year--but most of the growth will come from carrier sales, Wilson said.

In the bigger picture, 70 percent of Nortel's revenue comes from the carrier market, while 30 percent comes from corporate sales. Long term, the addition of Bay's technology will help drive Nortel's growth, Wilson said, even though some of Bay's technology may be subsumed into other portions of Nortel's business.

In the carrier space, Nortel is building new phone systems and fiber-optic equipment that combine voice technology with Internet routing to grab a larger stake in the lucrative service provider market. Similarly, Nortel is working its voice technology into Bay's enterprise products.

"The company is using the data networking technology to increase momentum in the carrier space, and at the same time, successfully repositioning the enterprise business for the world of the Internet," said Benn Mikula, head of technology research at RBC Dominion Securities.'s Ben Heskett contributed to this report.