Addition through subtraction is the theme of Ciena's ( CIEN) $900 million buy of metro optical shop ONI ( ONIS). But not everyone trusts this math.

The deal between the two unprofitable optical networking companies will combine their customer lists, which Ciena claims will bring 20 new prospective buyers. The new company would also have some 50% of the metro dense wave division multiple access, or DWDM, market. Phone companies, while pinching pennies, have dedicated a fair portion of their budgets to upgrades to their local, or metro, networks. And by next year, Ciena expects the deal to prove accretive to its bottom line, such as it is.

But observers remain skeptical. For one, Ciena is expected to lower its 2002 financial projections when it reports earnings this week, putting accretive assumptions to the test. And ONI, while heralded as a developer of leading optical tech, has yet to get the full blessing of the major old-line telcos, an essential customer group for survival in a spending slowdown. Both stocks rose modestly Tuesday morning, Ciena adding a dime to $8.83 and ONI rising 52 cents to $6.06.

Up With Products

The deal makes sense strategically in that it should permit Ciena to bolster its product line, but it is hardly a rally call to kick off a new round of mergers, say industry analysts and investors. Cash constraints and deflated stock prices have all but silenced the acquisitive streak in networking, leading some investors to speculate that desperation ranks high among the factors that led to this deal.

Unison
Small networkers fall together

Only the strong can combine, shoots back Ciena CEO Gary Smith, referring to the crushing fall of demand for networking gear and the impending shakeout of weaker players on the supply side of the industry. "Ciena is playing to win" despite the depression in the telecom sector, says Smith, who terms the combined companies a new-generation "powerhouse."

ONI shareholders will get 0.7104 Ciena share for each of their shares. Unlike deals done during the bubble era, Ciena's purchase of ONI doesn't call for a substantial premium above market value. ONI's market capitalization is $807 million.

"Synergistically it makes a lot of sense," says Lehman Brothers analyst Steve Levy. But numerically it's another story, he says. Ciena, which made 60 cents a share for 2001 as its sales showed solid early progress even as its rivals' numbers slumped, is expected to lose 66 cents a share for 2002. Likewise ONI's losses are expected to widen in 2002 to 65 cents, from 49 cents a share in 2001.

Investors will be treated, if that's the word, to another update to Ciena's deteriorating financial outlook Thursday morning. The company is expected to report a fiscal 2002 loss of 20 cents a share on revenue of $164 million. Year-ago earnings were 18 cents a share on revenue of $352 million.

The ONI acquisition "only looks nondilutive because Ciena is losing so much per share," says Levy, noting that ONI's $680 million cash hoard is attractive to Ciena, which is hardly cash-poor itself but knows pocketing a few pennies now can only help as the demand picture weakens further. Levy rates Ciena a neutral and is dropping his rating on ONI to neutral from strong buy. Lehman has no underwriting ties to either firm.

Accretive

Analysts on a conference call with Ciena and ONI executives Tuesday questioned the math, essentially asking how two money-losing companies can pair to make one money maker.

In an interview afterward, Ciena's chief strategy officer, Steve Chaddick, repeated Ciena's prediction that the deal will be neutral to earnings this year and accretive in 2003. The acquisition is expected to close by this fall.

But UBS Warburg analyst Nikos Theodosopoulos said in a note Tuesday that the combined costs and projected revenues don't line up so smoothly.

"Both Ciena and ONI have cost structures that are way out of line with current and forecasted revenues," the analyst wrote. "We estimate Ciena currently has a break-even quarterly revenue rate of $250 million to $260 million, as compared to the most recent quarter's revenue of $160 million."

Moreover, Theodosopolulos continues, "ONI has a break-even quarterly revenue rate of over $100 million per quarter, as compared to the most recent quarter's revenue of $42 million."

Some investors think words like "accretive" pale next to numbers like that.

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