So, Corning (GLW) - Get Report may swap half of itself for Nortel's (NT) optical-equipment business.

Four years ago, who would have dreamed of such a deal? Corning was a sleepy maker of Pyrex casserole dishes and optical fiber.

You have to give Corning enormous credit for having transformed itself in the past four years from a midtech glassmaker to a telecommunications-equipment leader, from chip-resistant measuring cups to whiz-bang optical amplifiers and laser pumps.

Started 149 years ago -- now

that's

Old Economy -- Corning might easily have gone the way of

Eastman Kodak

(EK)

, another longstanding upstate New York company (and one of the straggling outfits we looked at in

Thursday's On the Level). It could have seen its core business eroded by aggressive competitors and technological change.

Instead, CEO Roger Ackerman, backed by the founding Houghton family, quietly remade the company. In 1998, he sold off the kitchenware business and focused attention on the telecom business. He kept upping the research-and-development budget. And he went on a buying spree, snagging in the past eight months optical-component makers

Oak Industries

, for $1.8 billion, and

NetOptix

, for $2 billion.

Corning stock has become a play on the rebuilding of the telephone network and the build-out of the Internet. Everyone knows how hot the growth prospects are for those businesses, which explains the stratospheric takeoff in Corning shares in the past year.

Well, We Know It's Not the Upstate Water
Corning vs. Eastman Kodak and the S&P 500, five years

But not today. News in

The Wall Street Journal

that Nortel might swap its optical business for half of Corning ticked investors off. Corning shares fell 33 1/4, or 11.7%, to 250 for one simple reason -- dilution of its earnings if the deal goes through as reported.

The

Journal's

story didn't get into the earnings dilution issue, but it really matters to investors.

Issuing a Flood of Shares

Here's a back-of-the-envelope calculation to help get a handle on how much dilution might take place if the information in the

Journal

story is roughly on target. (I had help on this from an analyst at a major Wall Street firm, who would prefer to remain anonymous.)

Corning's market value last Friday was roughly $80 billion. It had 291 million shares outstanding trading around $275 per share. The

Journal

story suggested that Nortel wanted $100 billion worth of Corning stock for its optical business. Divide $275 into $100 billion and you see that Corning will need to issue about 363 million new shares. That would bring the total number of Corning shares postdeal to about 656 million.

What kind of earnings might Nortel's unit bring to Corning? In a release Monday, Nortel suggested that its unit should have revenue of $2.5 billion a year. The profit margin on the business, Wall Street estimates, is roughly 30%. So you can figure that the Nortel operation might bring, say, $750 million in extra profits to Corning. Add the $750 million to Corning's expected earnings of $945 million in calendar 2000, and you get $1.695 billion in estimated earnings for the new Corning.

How does that affect per-share earnings? $1.695 billion in net income divided by the 656 million shares outstanding postdeal equals $2.58. Previously, Wall Street was estimating that Corning would earn about $3.25 this year. So the deal suggests a 20% earnings dilution.

Corning Had to Drop, Could Go Lower Still

Of course, this is only a rough estimate. The deal terms may be meaningfully different from what we know today. There is no way to know until the companies release more information.

But what an investor can see now is that the potential for dilution is front and center. That is why the Street took one look at this deal and immediately lopped 10% off Corning Monday morning, then sent it even lower into the close: In the face of such uncertainty, you have to sell the stock down.

Could Corning go lower in the near term? Of course. Optical-equipment maker

JDS Uniphase

(JDSU)

slid for several days after saying it was going to buy rival

SDL

(SDLI)

. There were similar fears about JDS Uniphase paying too much, as well as

concerns about scrutiny from the

Justice Department

that could kill the deal. Justice could well review the Corning-Nortel deal too.

The proposed combination makes a lot of business sense for Corning in the long run. It will be better able to offer a wide range of optical products to the market. It will be better able to compete with JDS Uniphase.

At the end of the day, however, you must grapple with the valuation question. Is Corning a deal at 250? No one knows.

But Corning shareholders, take heart. At least you have an exciting deal to worry about. Pity those poor Eastman Kodak investors.