Big-Pockets Nortel Comes Calling, but Alteon Doesn't Get a Premium

In a brazen demonstration of just how much sway the big gorilla of the networking jungle possesses,

Nortel

(NT)

swept up

Alteon WebSystems

(ATON)

Friday, and it didn't even have to pay a premium.

In a market in which competitors have paid huge premiums over a target's stock-market value, Nortel is paying $7.8 billion in stock, exchanging 1.83 of its shares for each Alteon share, which values Alteon at $144 per share, barely a dollar above Alteon's Thursday closing price.

Nortel's share price slipped more than 6% Friday, effectively dropping the value of the deal below Alteon's takeover market price.

"It's the big take-under," says Jeff Wrona manager of the

PBHG Technology & Communications

fund, which recently sold its Alteon stake but holds a substantial Nortel position. "You see this in the oil or energy market but it's very unusual in the tech sector."

Sure, there's plenty of debate over the actual value of Internet infrastructure companies, especially those that are masters of the super-hot and forbiddingly complex gigabit ethernet domain, a standard language and data speed that allow computer systems to talk with each other. But from Alteon shareholders' perspectives, it was a bum deal. Its stock sold off 9.8% Friday, closing at 129.

Big Score for Nortel

For Nortel and its shareholders, the deal represents a coup. Alteon chose it instead of its networking partner

Lucent

(LU)

or even France's

Alcatel

(ALA)

, either of which might have been able to offer more money.

On paper, Nortel's willingness to pay $7.8 billion for a company that had $110 million in annual revenue actually sounds a bit rich, but perhaps is less so considering that Alteon controls 80% of a Web switch market that's projected to grow by more than 500% over the next four years, according to the

Dell'Oro Group

.

With the deal, Nortel gains a tremendous advantage in the rapidly growing data-storage market. Alteon's intelligent-switching systems inform a computer network about what type of information is being handled and whether it's going to a PC or a

Palm

device, for example. This gives Nortel a vital and lucrative extension of its already formidable lead in optical-networking products at the core of the Internet.

"You need these high-speed switches to direct traffic into data centers. These switches get rid of the bottleneck between the access routers and the storage network," says Gina Sockolow, a networking analyst at

Brean Murray

. (Sockolow rates Alteon a buy and has no rating on Nortel. Her firm has done no banking with these companies.)

The deal pits Nortel head to head with long-time rival

Cisco

(CSCO) - Get Report

in this access and data-storage arena.

Lucent Loses

And it's a significant blow to Lucent, which had a joint sales agreement with Alteon. "I think it's fair to say Lucent's partnership with Alteon won't last much longer," says Ron Westfall, an Internet infrastructure analyst with

Current Analysis

. (Current Analysis sells its research to most networking firms.) Lucent said it's too early to tell what will happen.

Nonetheless, Alteon shareholders didn't greet the deal with much glee. "Shareholders typically get real peeved when they don't get a premium," says Wrona, referring to the dollar value above the company's market capitalization that serves as a bonus for shareholders of the acquired company.

When Cisco in May

agreed to pay $5.7 billion for

ArrowPoint

(ARPT)

, a similar Web switching company, that price included a whopping 50% premium.

Using another measure: Cisco paid more than $25 million per employee for Arrowhead. This is often a metric used to gauge the value of the transaction, especially in highly technical fields where engineering brainpower is in such fantastic demand.

Nortel, which set an industry high-water mark of $36 million per employee in March with its

purchase of optical-switching developer

Xros

, will actually fork over a measly $15.6 million per Alteon employee.

Good Old Synergies

Nortel's chief operating officer, Clarence Chandran, on a conference call with reporters, said the premium would be evident in the synergies of the two companies.

Dominic Orr, Alteon's president and CEO, illustrated those sentiments on the call with some three-part logic. "The ultimate proof of value is that the Nortel/Alteon combination gets tremendous market share and market share generates gross margin and gross margin generates profits and that's really the way the deal should be looked at," said Orr.

It's not clear Alteon shareholders will buy into that logic or whether they'll express their opposition to the deal, which must gain their approval.

"Given the run the stock has had recently, this might be the best thing shareholders could hope for," says Wrona at PBHG. "I'm not sure they'll have much of a beef."