A Buyout Offers Bay a Way Out

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It's not just the arbs who hope

Bay Networks

(BAY)

is for sale -- some on Wall Street say it's Bay's best hope.

Sell-side analysts and investors are scratching their heads about what Bay executives actually said about takeover talks early Tuesday at a trade show in Las Vegas. Some people who attended the meeting say Bay executives didn't say the company had turned down an offer from

Northern Telecom

(NT)

.

Bloomberg

reported early Wednesday that Bay told analysts just that, but that it would consider other offers.

Bay's stock reacted to the news, soaring 3 15/16 to 27 15/16 on heavy volume by late afternoon.

Wall Street's consensus is that it selling is Bay's only way out. Otherwise, it will remain mired in the computer networking industry's second tier. The attraction is that Bay offers a way into the data networking market for corporations.

That's a far cry from the optimism that greeted CEO Dave House, an alumnus of

Intel

(INTC) - Get Report

, when he took over Bay in October 1996. House swiftly patched Bay's open sores by stanching the brain drain, clearing R&D clutter and getting a few strong products out the door. Operating profits started to rebound last spring, and investors pushed up Bay's stock 160% from late April to mid-October.

The press gushed. A

Business Week

story said in headlining a story, "Mr. House Finds His Fixer-Upper."

But sales slowed early this year, across the product line, and price competition gouged profits. In an interview early February, House seemed tired as he voiced caution about the quarter's outlook. Today, the turnaround is on the rocks, as evidenced by the past quarter's poor profits.

So as an exit strategy Bay reportedly wants to sell itself for 32 to 35 a share, or more than three times trailing revenue, according to one trader. That's still a healthy premium after the stock's rise today. One trader said enough arbs piled into the stock to keep the price aloft for a few days.

"It's a perfect play for anyone who wants to become, overnight, a player in the incumbent internetworking space," says Greg Rossman, principal at

Broadview Associates

investment banking firm. Rossman adds that House must either execute several strong quarters, or consider a partner. His firm advised Bay's recent investment in

NetSpeak

(NSPK)

and its acquisition of

Xylogics

in 1995; Rossman declined to say whether he's advising Bay now.

How did Bay fall this far?

"I don't think it's fair to pin any blame on Dave House," says analyst Amar Senan at

Volpe Brown Whelan

, which hasn't participated in any recent Bay underwriting projects. Senan says Bay is locked in the second tier along with

3Com

(COMS)

and

Cabletron

(CS) - Get Report

.

"These are companies that have succeeded in the past because of some new hot box," Senan says. Now, "I don't think hot boxes alone will do it." Now, Bay is unveiling new Accelar switches for corporations, along with products for so-called "virtual private networks" from a recent acquisition. But what drags the company is old baggage -- namely, so-called hubs that promise little growth but still form a sizeable chunk of revenue. 3Com and Cabletron, Senan says, have a similar quandary.

Now Bay hopes for an angel -- most likely a big supplier of phone gear that will acquire it to extend into data networking for corporations.

"Bay, as a matter of elimination, is a most attractive candidate," says a sell-side analyst who asked not to be named. 3Com is still a little pricey, and Cabletron has lost too much market share, he says. The analyst maintains that Bay has gained market share, despite the recent damage of a product transition and price competition. (Ascend

(ASND) - Get Report

also is an attractive

acquisition candidate, though for a bidder seeking to bolster its presence in the data market for phone carriers.)

The rumored acquirers are

Lucent

(LU)

,

Northern Telecom

,

Ericsson

(ERICY)

and

Alcatel

(ALA)

.

Northern Telecom, Ericsson and Alcatel each wants to beat giant Lucent. And there may be a window of opportunity for some of these companies: Lucent can't acquire a company using a pooling-of-interests transaction, the most desired method, until October, two years after it was spun off from

AT&T

(T) - Get Report

.

Officials at Lucent and Ericsson declined to comment. The others could not be reached for comment.

Lucent, which has resold Bay products in recent months, seems to some an unlikely acquirer.

"The relationship between Lucent and Bay, while still friendly, has cooled since they signed the deal," says the sell-side analyst. The companies were wary of sharing competitive information, which stifled the alliance. His firm hasn't performed underwriting for Bay.

Rossman at Broadview says Nortel boasts a strong distribution channel for selling phone systems to corporations; he finds Alcatel less likely because it focuses on wide-area networks rather than the small corporate systems on which Bay focuses.