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Telco takeovers, round 2
Equipment companies like Lucent, Nortel and Ciena may finally have to succumb to the urge to merge.
July 5, 2005: 9:08 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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Many telecom equipment firms have struggled during the past five years...and times could get tougher as their customers merge.
Many telecom equipment firms have struggled during the past five years...and times could get tougher as their customers merge.
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NEW YORK (CNN/Money) Lucent. Nortel. Ciena. 3Com. Tellabs. Remember them?

All of these network equipment companies, Wall Street superstars in the late 1990s, now trade in the single-digits.

But there is a glimmer of hope as a long-awaited period of consolidation could finally get underway.

"There needs to be rationalization in this industry," said Timm Bechter, an analyst with Legg Mason. "No one vendor has a major share."

That's going to have to change, especially since many of the equipment firms' top customers, large telecom service providers, are busy merging with each other.

Customers getting bigger

Sprint is buying Nextel. SBC is gobbling up AT&T. Verizon is acquiring MCI. And even smaller telecoms are bulking up. Alltel, for example, is purchasing Western Wireless.

And there could be more deals. According to recent reports, Deutsche Telekom is said to be considering a sale of its American wireless unit, T-Mobile USA.

Usually, a massive wave of consolidation in one part of an industry has a ripple effect. For example, the three big oil mergers in the late 1990s and 2000 Exxon and Mobil, BP and Amoco and Chevron and Texaco -- eventually helped to spark a round of mergers among oil services and drilling companies in 2001.

The rationale is that suppliers should bulk up when their customers are getting bigger since larger customers typically prefer to deal with fewer suppliers. In addition, larger customers tend to have more leverage to negotiate prices.

So with all the mergers among telecom carriers, the next few years could be tough for equipment firms unless they also consolidate.

"There could be a lot less spending. Most of the network build-out for larger telecom players is already done," said Bechter.

So who could be buyers and sellers? Bechter said that some of the leading European telecom equipment vendors, such as Sweden's Ericsson (Research), might consider going after Lucent (Research) or Nortel (Research) to increase its presence in the North American market.

Along those lines, the rumor that apparently never will die, that of France's Alcatel (Research) being interested in Lucent, is still making the rounds this summer. The two firms were working on a merger more than four years ago but talks collapsed before a deal could be done.

Going private an option?

Still, consolidation may not necessarily take place in the form of mergers between large rivals.

"If anything, a more likely trend is privatization among some of the smaller equipment operators," said Eric Buck, an analyst with Janco Partners.

Several tech companies have announced plans to go private during the past year, including cable firms Cox, Insight Communications and Cablevision, Internet advertising agency DoubleClick and software firm SunGard Data Services.

Of course, betting on mergers is highly speculative so investors need to be wary. And even though there is an obvious need for consolidation in telecom equipment, that isn't exactly new. It's been apparent since the tech bubble burst in 2000.

And Buck adds that many of the oft-mentioned takeover targets in the United States might not be as attractive to large equipment firms as companies in foreign markets.

"There are higher growth opportunities internationally. We have some fairly entrenched players in a relatively slow growth market in the U.S. so incremental investments would make sense in markets like South America, Asia and India."

Still, the recent round of telecom mergers in the United States could be the catalyst that finally gets some equipment companies to realize that the only way to effectively deal with bigger customers is to get bigger as well.

"It's very simple. There are too many equipment companies going after too few dollars," said Bechter.

For a look at networking equipment stocks, click here.

For more market news, click here.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking relationships with the companies.


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Written by: By Paul R. La Monica
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