Cultivating a Network

Telecom mergers and acquisitions are at a fever pitch as new technologies and changing markets force consolidations.

Even among the high rollers of the telecom industry, Zhone Technologies has to be considered a big spender. Since 2000, the company has bought a dozen companies for a total bill of $600 million. Zhone boasts it is assembling all the necessary parts to build a state-of-the-art network that will deliver voice, data, and video to customers, but to date the company hasn’t earned a dime on its products. In fact, since 2000, Zhone has lost hundreds of millions of dollars.

What makes all this even more remarkable is that Silicon Valley doesn’t seem at all fazed by the company’s five-year spending spree — and neither does Wall Street. After all, Zhone is just one among dozens of telecom companies engaged in heated bidding for acquisitions these days, pursuing deals that collectively total in the billions of dollars. “Telecom is in the midst of an arms race,” says Ping Zhao, an analyst with CreditSights Ltd. in New York. “Intense pressures are changing the competitive landscape and setting the stage for some very aggressive dealmaking. M&A activity is going to be at a fever pitch for the foreseeable future.”

Telecom has long been a hotbed of M&A. Cisco Systems Inc., famous for having cobbled together 104 companies since its founding in 1984, today dominates the world’s networking industry. The telecom boom, fueled by the Telecommunications Act of 1996, set the stage for the WorldCom fiasco, among other spectacular crashes of telecom stocks. What makes the current spending spree so interesting is the scope and scale of today’s consolidations. Even more remarkable, especially given recent history, is that some of the biggest spenders aren’t exactly on firm financial ground. Apparently, hundreds of millions of dollars in losses — or even bankruptcy court — don’t blunt the ambitions of these high rollers.

Big Buys and Small Deals

Consolidation is reaching every corner of telecom. The titans of service are forging megamergers — look at Verizon’s recent $7.6 billion purchase of MCI and SBC’s $16 billion acquisition of AT&T, for example. Such combinations produce huge economies of scale amid rising consumer demand and falling prices for voice, data, and video communications. Meanwhile, telecom’s big equipment makers are racing to establish a competitive edge after five long years of a deep and painful shakeout.

Analysts believe large-scale consolidation among those equipment giants is unlikely, though some of the deals are near-billion-dollar transactions. Instead, the companies are more likely to continue snapping up smaller concerns in an effort to gain access to new technologies or markets. Not all the deals will be acquisitions, though. Analysts expect to see a bigger crop of joint ventures, especially with competitors in Asia, as the biggest players seek a path to the global marketplace. “Chinese equipment providers are going to shake up the market,” says Ron Pillar, head of communications-technology investment banking for JP Morgan Chase & Co. in New York. “They will be a serious threat.”

That’s the thinking behind the strategy at Nortel Networks Corp., which is forging global alliances at the same time it is buying carefully chosen targets. Earlier this year, Nortel, a telecom-equipment supplier in Ottawa, Canada, announced a joint venture with LG Electronics Inc. that will, among other things, provide a very-high-speed broadband wireless network for KTF, a leading cellular provider in Korea. Shortly after, Nortel spent $448 million to buy PEC Solutions Inc., in Fairfax, Virginia, which provides IT services to state, federal, and local governments in the States. The acquisition will allow Nortel to mount a coordinated attack on the lucrative government market, notably to such agencies as the Federal Bureau of Investigation, Immigration, Customs, and the Department of Homeland Security. Nortel CFO Peter Currie doesn’t rule out the possibility of more big buys, either. “We’re looking at a lot of opportunities,” he says.

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