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DEC sells network unit to Cabletron

Digital Equipment sells its network products division to Cabletron Systems for $430 million in cash, stock, and product credits.

Digital Equipment (DEC) has sold its network products division to Cabletron Systems (CS) for $430 million in cash, stock, and product credits.

The new unit will be called the Digital Network Products Group: A Cabletron Company, according to Cabletron.

"The rest [of the payment] will be in product credits to Digital," Cabletron spokesman Darren Orzechowski said. He added that, Maynard, Massachusetts-based Digital "has made a commitment of $1 billion in sales over the next three-and-a-half years."

Government approval for the long-rumored deal is expected to take 60 days, Orzechowski said.

Earlier this month, Digital chief executive Robert Palmer said it was important to have "critical mass" in the consolidating network industry and that DEC would search for a partner to provide the products.

The acquisition is the first for Cabletron since Don Reed joined the Rochester, New Hampshire-based computer networking product maker as chief executive officer in September. Reed promised a very aggressive acquisition strategy.

"This deal has been talked about for some time and a lot of us have been waiting for it for quite awhile," said Standard & Poor analyst Megan Hackett, who follows both companies. "The $430 million represents one-time revenues."

"It's pretty much a good strategy for both companies," she said. "Digital gets out of a business it was never strong in, and Cabletron gets its products out."

Reed said the acquisition addresses two areas he hopes Cabletron will improve in: sales through third-party channels, and sales to international customers. "This is the first initiative in our strategy to rapidly expand Cabletron," the recently-hired CEO said. "There will be more."

Palmer, Digital's embattled chief, said the sale of the networking business caps his strategy to lose elements of the company's operation that did not fit in with his long-term goals. He said that networking suppliers increasingly were becoming providers of products for end-to-end layouts and that he did not feel Digital could invest sufficient funds to take advantage of that trend.

"This agreement completes the strategic plan we put in place years ago," Palmer said, noting that it also opened up the possibility of investments for the firm.

Reed said that, by retaining the Digital brand name and adding it to Cabletron equipment sold through the Digitial sales channels, the venture can "get out of the blocks quickly." Reed said he wants 50 percent of Cabletron's sales to come from international markets, and hopes 60 percent of revenues eventually will be derived from third-party resellers and integrators.

For Cabletron, which also gets 900 Digital workers with marketing and engineering talent along with 250 patents, the acquisition means it expects to raise its annual revenues to $2 billion from $1.5 billion.

"It helps them strengthen and freshen their product line," Hackett said. "What this is, is a weak networking company buying a weaker networking company."

Under a strategic partnership, DEC will sell a set number of the unit's products, as well as other Cabletron products, to its customers, and will service and guarantee them.

The deal will boost Cabletron's international sales by 35 to 40 percent and double its channel revenues (indirect distribution channels), the companies said in a joint statement.

DEC's network unit currently generates more than half of its sales outside the United States, primarily through a network of third-party distributors.

One analyst said the acquisition of new distribution channels is a plus for Cabletron. But overall, the deal raises some questions.

Matt Barzowskas, a vice president at FAC Equities, sees the deal as neutral to negative for Cabletron. "This gives them a way to expand channels and overseas distribution. But they have to work through some integration issues, and you do have product overlap at the higher end. [The acquisition] seems to just create confusion."

The acquisition also does nothing to help Cabletron address a glaring weakness, Barzowskas said. "To continue to be a major player, Cabletron needs to have more products in the high-end telco space, and they have to provide a more advanced remote access solution and a routing switch. 3Com just introduced products in this area, as has Bay Networks. Cabletron doesn?t have a migration path to that area yet."

Shares of Digital and Cabletron dipped in late morning trading, as investors failed to be impressed with the deal.

J.P. Morgan also cut its rating on Cabletron to "market perform" from "buy."

"We believe that Digital's [networking] business is a deteriorating one, and that it lessens the possibility for upside surprise over the next four quarters," analyst William Rabin said in a research note.

Rabin said management's ability to improve the company's short-term growth rates were his primary reason for the buy recommendation. He added that the Digital acquisition may now hinder short-term plans.

But for Digital, the deal is a windfall of cash and lifts the burden of supporting a troubled unit off of top management's shoulders. "They get cash and get away from a product line where they would have to keep struggling to build new products and to keep up with competitors," Barzowskas said. "And they can continue to sell their service business, which is a strength," he said.

Last month DEC sold its chipmaking operations to Intel (INTC) for $700 million as part of a patent suit settlement.

Reuters contributed to this story