Nortel puts Metro Ethernet group on sale block

Nortel announced on 17 September 2008 that it was revising downward its guidance for 3Q and full-year 2008 and that it was "exploring the divestiture of its Metro Ethernet Networks business." Both of these announcements have far-reaching implications for the packet-optical networking market and industry as a whole.

Nortel is the second wireline infrastructure equipment vendor to lower guidance in the past two weeks

Nortel's announcement is another sign that the deteriorating macro-economic environment is starting to affect carrier and enterprise capital spending. The company cited cutbacks in capital spending as one of the chief reasons for its revision. Ciena announced on 4 September that it too was experiencing order delays associated with the weakening economic environment, causing it to revise its 2008 outlook.

Although it did not make any new announcements, AT&T has already reduced its capital spending in some areas, affecting 2Q08 ON spending.

The steady stream of bad news this week is not encouraging; we expect more negative news and lower revenue and capex guidance ahead. However, the fundamental need for bandwidth is not going away. Network operators may elect to run networks hotter and delay projects until financial conditions improve, but that is only a short-term fix.

Operators say that they will continue to spend on priority projects in high-growth areas, but they are "battening down the hatches to weather the storm".

Nortel combined its separate ON and carrier data switching businesses about two years ago, creating the Metro Ethernet Networks (MEN) division, which has been one of the strategic thrusts for the company. The company is a strong competitor with a good optical and data networking portfolio built on solid intellectual property.

Nortel is currently the third-ranked ON vendor globally and boasts that it has over 400,000 network elements deployed in over 150 countries worldwide. The company has taken a lead role with PBB/PBB-TE, electronic dispersion compensation, and other new technologies such as 40G/100G.

Nortel cited strategic reasons and the desire to monetize the value of its MEN business to shore up its balance sheet as the rationale behind the divestiture.

The company provided no details regarding possible suitors, but did say it was a safe assumption that it was looking for a cash transaction. I did find it interesting that it used the term "explore the divestiture". I'm not sure what that means but I suppose one of the company's lawyers made it state it in that way.

Given the current state of the global economy and the tight credit markets, I'm not sure who could raise the money to make a valid offer. Huawei is the first company that comes to mind. It is the second-ranked ON vendor globally and is very interested in cracking the North American market. It is also supported by the Chinese government and may have access to capital that others don't.

Still, Huawei has had spotty success with JVs and acquisitions to date and there is a huge cultural wall that the company would have to scale in order to succeed.

Others that come to mind are Cisco and Juniper, which may be considering a deeper dive into ON.

 

A more established ON company like ECI, Ciena, Sycamore or Tellabs may also be interested, but the price may be too high for all of them except Cisco - and while I believe that Cisco would be interested in Nortel's 40/100G technology, I don't think it is interested in the rest of the division.

Nortel has taken a huge risk in announcing its intention. Generally acquisition and divesture discussions are conducted behind closed doors in as much secrecy as possible.

The company needs to close the deal soon. It has given competitors a huge weapon against it and it risks alienating its customers and prospects, which will wonder why they should deploy NT gear now with the future of the company so uncertain.

Additionally, the thousands of people that make up Nortel's rank-and-file staff are now worried about keeping their jobs rather than focusing on the task at hand.

Nortel's MEN business is a valuable asset that would immediately bolster any company's ON business. We should get a good indication of the health of the ON market by how quickly and for what price a deal gets done.

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