Nortel to Purchase Xros in $3.25 Billion Stock Deal

The move brings Nortel closer to throwing the switch on an all-optical network.
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Updated from 10:27 a.m. EST

Nortel Networks

(NT)

said Tuesday that it would buy

Xros

for stock valued at $3.25 billion, as Nortel comes closer to throwing the switch on an all-optical network.

Shares of Nortel rose 2 1/16, or 2%, to close at 123 3/4.

Xros, a privately owned business based in Sunnyvale, Calif., makes switches that use tiny mirrors to reflect beams of light that carry data along network lines. The benefit is that these switches allow a greater capacity of data to flow through the switches without causing bottlenecks.

The life span of a new independent company in the optical equipment business is a matter of months. Only last November, Xros chief executive Greg Reznick rounded up $20 million in venture funding for his optical networking start-up. Primary backers of the company

Menlo Ventures

,

New Enterprise Associations

and

Greylock,

identified early on that the market would be lucrative.

"For us the timing (of the merger) is opportune in going from development to implementation," Greg Reznick president and CEO of Xros said in an interview. "Nortel brings us the know-how to do that."

Nortel, the huge supplier of communications equipment from Ontario, said the acquisition of Xros would enable it to build the first all-optical network.

"It was a deliberate and offensive move," Greg Mumford, president of Nortel's optical networks unit, said in an interview. "The Xros merger is simply the next step getting the photonic switch needed. As soon as we identified someone with the right technology, we moved very quickly." Mumford added that Nortel would expect to continue internal development and making acquisitions "where it makes sense."

Sanford Bernstein

analyst Paul Sagawa isn't convinced that Nortel will have the first all-optical network.

"It's rhetoric," he said. "It's a product they can't deliver right now." Sagawa rates Nortel a market outperform and his firm does no underwriting. But the advances toward all-optical networks have made him bullish for the optical equipment sector. He rates Nortel competitors

Cisco

(CSCO) - Get Report

and

Lucent Technologies

(LU)

both market outperformers.

"An all-optical Internet will deliver millions of instant Internet sessions, thousands of video channels, and vast amounts of e-business transactions on an unprecedented scale," Clarence Chandran, president of the service provider and carrier group of Nortel, said in a statement.

The race to build out optical networks has became more competitive as Nortel filed a lawsuit Monday accusing a rival,

Optical Networks

, of using its trade secrets.

The suit seeks an injunction to stop Optical Networks from selling an optical switch similar to Nortel's own switch or soliciting or using Nortel's trade secrets. It also seeks damages, including profits lost through the alleged patent infringement.

Nortel won an injunction against Optical Networks last year to prevent top employees from defecting to the privately held company to take similar jobs to those they had held at Nortel at various stages of the optical switch's development.

Competitors in the market including

Cisco

, which owns part of Optical Networks, and

JDS Uniphase

(JDSU)

are investing billions of dollars for acquisitions to increase network capacity and promote their own products lines.

"Lucent and Nortel keep spurring each other on. There certainly is pressure to keep the ball moving." Last year Lucent announced an optical switch called the Lamdarouter, which caught Nortel by surprise.

Last week, Lucent Technologies said it planned to invest more than $650 million over the next two years to expand its fiber-optic cable business by adding 300 jobs and manufacturing capacity to its optical and fiber factories.

But it was powerhouse Cisco that set the market on edge last year when it paid a startling $7 billion for privately owned

Cerent

, which was founded two years earlier. Cisco went on a warpath buying almost everything they could get their hands on, including a

deal to buy Italian optical component maker

Pirelli

for $2.15 billion and adding two more optical companies,

Monterey Networks

and

PipeLine

.

Nortel

countered in December with a

Qtera

acquisition of $3.25 billion. Qtera's technology that allows fiber optic lines to carry signals farther than usual.

Sagawa doesn't think the wild spending sprees will end anytime soon. "You're going to see accelerating spending which will benefit all these companies," he said.

Nortel can afford more acquisitions with their stock at 100 times expected earnings, Sagawa noted. "Cisco, though, has been strangely cautious, wondering how to integrate after a flurry of acquisitions."