Alcatel-Lucent has potential, but dangers too

Merger could come as soon as Tuesday, say industry sources

Lucent Technologies last week landed a DSL deal with the only US regional Bell that Alcatel had failed to partner with, Qwest Communications International, and that could make the courtship of the two equipment behemoths just sweet enough to make a marriage.

Executives at the two companies last week announced that talks were fruitful enough to continue. Observers say there is a 50 percent to 60 percent chance that a deal can be made, possibly one that has Alcatel acquiring Lucent in a stock deal worth $34bn -- Lucent's current valuation -- or a little more. Industry sources said a deal could come as soon as Tuesday.

An Alcatel-Lucent merger could push Nortel Networks to seek a merger with Ericsson or another European vendor so it could match the strength of reaching both the North American and global markets in dozens of spaces, said Blaik Kirby, vice president at Boston-based consultant firm Adventis. Nortel last month killed its DSL product line and, like Lucent, has equipment that is up to 10 years old.

The Qwest-Lucent deal didn't cement the merger talks, but it would give Qwest peace of mind -- that if Lucent isn't committed to DSL, it could turn to Alcatel's product line, Kirby said. A merger of such giants always requires tense talks on which product lines to merge, fold or expand.

"Alcatel doesn't have a lot of strength in the US marketplace," Kirby said. A merger would "help Lucent sell equipment in the rest of the world and give Alcatel a deeper US portfolio".

An Alcatel-Lucent deal could spark other mergers, too, said Deb Mielke, principal at research firm Treillage Network Strategies. "To me, a smart move would be if some long-haul optical guys like Sycamore [Networks] teamed with Extreme [Networks], Foundry [Networks] or Riverstone [Networks]." Such mergers could give carriers another powerhouse from which to buy their core, metro and access gear. Foundry, Extreme and Riverstone have switches for the enterprise and metro markets. If they could team with a long-haul player, "that would make them pretty powerful."

There are plenty of reasons why Alcatel would balk at acquiring Lucent and its mountains of debt and inventory. But it pines for three things from the former Bell Labs. Lucent's US customer base and its optical technology are two. The third is the DSL deal with Qwest, the only regional Bell that hasn't announced a deal with the Paris-based Alcatel.

Jaws dropped all over the telecom industry in the late 1990s when the French company announced deals with all but one of the regional Bells: Ameritech, now SBC; Bell Atlantic, now Verizon; Bell South; and Pacific Bell. Only U S West, which served 14 western states, balked.

Last week, Lucent announced that it would be the major vendor as Qwest, which acquired U S West last year, steps up its DSL deployment in 11 states. Qwest plans to install DSL in an additional 2.5 million homes and small businesses by the end of next year.

The competitive local exchange carriers' aggressive push into DSL had forced the incumbents to keep up, reluctantly, in the low-profit space. But the CLECs' infrastructure costs were too high for their low neighbourhood penetrations, and many, such as NorthPoint Communications and Rhythms NetConnections, are in bankruptcy or on the verge.

The demise of the CLECs removed some incentives for the incumbent local exchange carriers to extend DSL service beyond the three-mile radius from central offices. At the 2000 rate of expansion, the ILECs would take 30 or 40 years to bring DSL to all of their customers.

But in the past couple months, as a bill that could ease regulations on the regional Bells has been wending its way through Congress, things have been hopping in DSL. SBC announced a plan to build thousands of neighbourhood nodes, connecting homes and businesses via a passive optical network device.

And last week, Lucent announced that it would install its remote terminal devices in Qwest's new neighbourhood cabinets for 2.5 million homes. "It dramatically expands the DSL serving area beyond the 3-mile limit," said Lucent spokeswoman Brooke Houston. The 2.5 million lines compares to just 2.4 million lines installed in the United States all of last year, and a projected 5.7 million lines this year, according to estimates by TeleChoice market research firm.

"We're very serious about bringing DSL to more customers as quickly as possible," said Murray Smith, vice president of DSL at Qwest. "In the past, we weren't able to deploy this technology," but partnerships with Lucent and others now make the economics work.

Lucent is everywhere, across the globe and across all layers of network architecture, but can spread itself too thin and be late with new technology. This year it spun off its microelectronics division, Agere Systems. Lucent has shown a bounce this month with deals with Global Crossing for wavelength routing; China Unicom for wireless technologies; OmanTel of Oman and Globe Telecom of the Philippines for customer services; B-Telecom of Belgium for optical networks; and Portugal's major telecom for broadband video and telephony.

While Alcatel is the strongest global DSL player and has relationships with regional Bells in that technology, Lucent is much stronger with the Bells in legacy switches and optical technology.

"There could be some good synergies in the North American customer base," said RHK analyst Brian Van Steen. "But, I have my doubts. Whenever large companies merge, there are a lot of issues that need to be overcome -- a lot of deal-breakers."

Lucent may sell off some divisions to reduce its debt before Alcatel commits, he speculated. If the merger happens, carriers will have one less major vendor from which to buy, and that will "leave possible inroads for some of the smaller guys," Van Steen said.

Lucent and Alcatel "have a ton of overlap in [Asynchronous Transfer Mode] and DSL," Mielke said. "Lucent has a lot of problems. Their softswitch doesn't work. Their Cascade stuff is 10 years old."

But Lucent's customer relations are still important for Alcatel. "It's hard for Alcatel to sell here," Mielke said. "They're behind in optical, too."

Depending on how the deal is structured, the combined company could be classified as an international firm, which means some portfolio managers would drop it from their lists. As a spin-off of AT&T, Lucent is one of the most common US mutual-fund stocks, even though it is down 85 percent from its 52-week high. "On the other hand, a lot of Lucent stockholders will be glad to get Alcatel," Mielke said.

Some carriers that have relationships with Lucent probably are happy to see the Alcatel talks, she said. "I'm sure Lucent would just love to do it."

And Alcatel? "The US market is huge, it's really tough to crack and everybody wants into it," Mielke said. "Siemens hasn't really cracked it, Hitachi, Ericsson, Fujitsu, none has really cracked it. With Lucent, Alcatel gets an installed base and a bunch of feet on the street to establish relationships. Carriers do buy from people they trust. If Alcatel can retain those relationships built by Lucent, it could be a powerful company."

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