Nortel merger key to networking future

To hear chief executives David House and John Roth tell it, the merger of their two companies is a match made in heaven.

Sticking to the script, the chiefs of Santa Clara, California-based Bay Networks and Canada-based Northern Telecom said in an interview with CNET NEWS.COM that their multibillion-dollar merger of voice and data-based equipment providers is just what the networking market is seeking.

The merger of Bay, a $2 billion data networking firm, and Nortel, a $15.5 billion telecommunications equipment provider , is the largest of its kind, formally ushering in a Net-driven era that has been gathering momentum for some time: the convergence of networking technology that is bringing together voice and data traffic on a single network, with the quality and performance of separate, dedicated systems.

As part of the convergence trend, a merger bug has swept through the telecom and data networking industries in recent weeks, creating what could be viewed by some as a new barrier to entry for networking firms.

Ericsson is reportedly looking to add data equipment capacity, possibly via a deal with Ascend Communications. "That would be a really good fit," said Jeremy Duke, analyst with market researcher In-Stat.

Unconfirmed reports also have linked Alcatel Alsthom with Xylan, a local area niche player.

House and Roth seem acutely aware of this trend.

"The Web is dramatically changing the way networks are built," said Roth.

The new Nortel created by the Bay deal could trigger a scramble among smaller players to cement relationships or be acquired by larger firms. "It's a revolution that's happened so quickly," Duke noted. "[Smaller networking companies] are going to have to team up or they're going to fall by the wayside."

For Bay, the deal reopens a giant window of opportunity that was closing due to fierce competitive pressures against data kingpin Cisco Systems and others.

House arrived at Bay's door about a year and a half ago with an impressive legacy at Intel behind him and an organization in turmoil staring him in the face. In the short term, House essentially completed the acrimonious merger of Wellfleet Communications and Synoptics that gave birth to Bay and righted a sinking ship.

House also installed the first relatively coherent strategy for Bay's core business in years, no matter how broad his brush strokes seemed at times. And he was rewarded handsomely for his efforts.

At a regularly scheduled meeting between Bay executives and service providers last month, however, it became apparent to House that what was once a theoretical understanding of an upcoming convergence of voice and data traffic among customers had become, as he termed, "a gut-level, visceral, emotional panic" due to the implications of the shift for their businesses.

"There was a realization that data had surpassed voice in terms of bits on a network," House said.

Though Bay could be viewed as well-positioned to take advantage of this industry inflection point, House may have reasoned that a $2 billion data player among larger data firms such as Cisco Systems was not a good formula for success. Similarly, Nortel's Roth may have taken a look at his aging circuit-based voice technology and realized he needed more data capabilities if he was going to butt heads with competitors.

Maribel Lopez, an analyst with Forrester Research, said a data-focused acquisition by Nortel was a foregone conclusion: "I see Nortel looking around at the competitive landscape saying, 'I've got the Cisco dragon breathing fire over here and I've got Lucent everywhere I look.'

"The way Nortel sees it, they're at least buying a player," she added.

Nortel's stock promptly plunged on news of the merger. What was a $9.1 billion deal on Monday had turned into a little over $7 billion merger by the end of Wall Street trading on Wednesday. The deal is expected to close in the third quarter.

And Nortel remains bullish on the prospects for its circuit-based switching equipment. "While data is chewing up the capacity of voice networks at a rapid pace, it's voice that continues to pay the bills," Roth said.

But what will drive the company forward is not products currently available, but a new series of high-end equipment--likely in various stages of development--that supports data and voice traffic and uses IP, or Internet protocol, as the transport mechanism.

"The merger makes perfect strategic sense," said Michael Duran, analyst with Lazard Freres & Company. "The risk part to fulfill this dream is you've got to get the voice guys working with the data guys."

Added In-Stat's Duke: "What they're talking about is really potential because they don't have a true IP product."

How the Bay and Nortel merger plays out could offer a crash course in how to approach this so-called Era of Convergence.