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Business is obviously pretty good when you can shelve a $100 billion deal without missing a beat.





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Thursday called off talks that would have combined Nortel's $2.5 billion-a-year component business with Corning, creating an optical-components powerhouse under Nortel's majority ownership. Analysts say both companies wanted the deal, but Corning couldn't stomach ceding control. Both stocks slid Thursday amid a widespread tech selloff, with Corning dropping 1.4% and Nortel 5.9%.

The companies parted amicably and may yet restart talks, say industry observers. But for now, the talks highlighted the fact that Nortel wants to find a partner for its lush optical business, so it can focus on its equally hot core network-systems business. And with

JDS Uniphase


having bought out half the optical world, Corning looks like the only game in town.

Seeing Is Believing

It has been increasingly clear that Nortel finds itself traveling two paths and is exploring the possibility of focusing on just one, namely its core business of making network-equipment systems. CEO John Roth signaled to analysts on the company's earnings call Wednesday that building components is an incredibly valuable, but nonetheless secondary, business. He said he'd prefer to have the company spend less money on manufacturing its components and would rather buy these supplies on the open market. Corning didn't return calls Thursday seeking comment, and Nortel declined to go beyond its press statement.

"Of course, we all thought that move was going to happen in a matter of 48 hours,"

TD Securities

analyst Mark Lucey says of the Nortel-Corning linkup. "But as long as

a deal happens in due course, I think it is consistent with the evolution of Nortel into a more focused enterprise." Lucey has a buy on Nortel and no ratings on its competitors. TD Securities has done banking with Nortel.

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"If Corning couldn't buy it, that doesn't mean Nortel wasn't trying to sell it," adds Jay Liebowitz, optical components analyst for


, a South San Francisco, Calif., research firm that consults to most of the networking firms.

Driver's Seat

Nortel faces an interesting quandary. It can offer two things that the market is desperately demanding these days: surplus optical-component supply and abundant manufacturing capacity. These factors seem to beg for a solution.

But unlike



, which last week set plans to spin off its microelectronics division, Nortel's component business wouldn't stand very easily on its own, says Lucey.

Nortel is basically its only component customer: Some 85% of Nortel components are sold internally. That's not quite the broad customer base that businesses prefer to rely on for success. In addition, says Lucey, the component business would need to find a marketing and administration staff right away. No small task.

Nepotism Doesn't Work

Also, Nortel's component business helped give Nortel a huge advantage over rivals because it provided plenty of the crucial 10-gigabyte lasers that gave Nortel a runaway lead in that higher-capacity optical gear market. So now, with a safe lead and sufficient supply, Nortel could conceivably sell surplus to the competition.

The difficulty with creating a partnership with another component company is that Nortel would have to devise a way to produce a line of common parts for itself and its competitors, while retaining exclusive access to a supply of the more strategic next-stage 40-gig laser components. This favoritism wouldn't endear the company to competitors.

Hence the forces behind the highly complex deal with Corning, which was also a function of a rapidly consolidating optical-components industry. The proposed $41 billion merger of JDS Uniphase and



could still help push Corning into Nortel's arms.

So finding a way to squeeze even more money out of the enormous pipeline of cash flowing to optical-equipment firms has become one of Nortel's bigger challenges at this point. All things considered, it's not a bad problem to have.

"I don't think this news is a significant strategic blow to either company," Lucey concludes. "The Street is far more interested in Nortel's systems business."