SAN FRANCISCO -- If Intel (INTC) - Get Report can't beat 'em, it will buy 'em. The chip giant is paying $2.2 billion to buy network chipmaker Level One Communications (LEVL) - Get Report, a deal Intel has hinted at for the past few weeks.

Under the terms of the deal, announced after Thursday's market close, Intel will exchange .43 shares of its stock for every share of Level One, issuing a total of 18.6 million shares. The purchase is Intel's biggest to date, almost six times more than the $387 million it spent to buy graphics chipmaker

Chips & Technologies

in 1997. Intel closed at 113 3/8, a 1.2% decline for the day. Level One dropped 16% to 27 1/8 on a downgrade by

Adams Harkness & Hill

.

Rumors have swirled for months about Intel buying out a networking company. In September,

TheStreet.com's

own

Herb Greenberg suggested that Intel would buy

3Com

(COMS)

.

Today, Intel Vice President Mark Christensen tried to put that rumor to rest. "We have no plans to enter into the enterprise or voice telco market," he said, adding that with the Level One acquisition, Intel expects both 3Com and

Cisco Systems

(CSCO) - Get Report

to become major customers of Intel's networking chips.

The acquisition marks a dramatic change in strategy for the world's biggest chipmaker, says

Nationsbanc Montgomery Securities

analyst Jonathan Joseph. Until recently, the company believed it had the capability to develop everything internally. "They thought that if anything was worth developing then God would have given them a developer for it," he says.

But no more. Besides the latest acquisition, Intel has been making dozens of investments, putting $2.5 billion in a

venture capital fund spread throughout the electronic communications industry. Intel also formed a partnership recently with

Analog Devices

(ADI) - Get Report

to develop a new architecture for digital signal processors, a type of chip used in wireless communications. Intel closed a $185 million acquisition Monday of

Shiva

, a company that develops remote access technology.

Intel also has a small stake in

Broadcom

(BRCM)

, which makes chips for cable modems, and competes directly against Level One in fast ethernet. But aside from a return on its money, Intel has no product alliance with the company.

Intel wants to dominate the networking chip market, says

NationsBanc Montgomery Securities

analyst Clark Westmont. "The dream is to be Intel inside networking," Westmont says. "But I think there are a lot of challenges to making that happen." (Montgomery has an underwriting relationship with Level One, but not Intel.)

Elias Moosa, a semiconductor analyst with

Thomas Weisel Partners

, says Intel bought the stake in Broadcom to ensure itself a place in the cable modem market. It's buying Level One, he says, because Intel has been losing ground in the growing ethernet market. "3Com was actually beating Intel in chip development," Moosa says. (Weisel has no underwriting relationship with Intel or Level One.)

Intel has had a large market share in networking products for the PC and for equipment used by small businesses, but Level One puts them in a higher field -- that of chips for networking systems, the Internet and intranets. "It's really something new for us," says Intel spokesman Robert Manetta. "Level One is a building block supplier."

The acquisition is a bigger version of one made last year by Intel competitor

National Semiconductor

(NSM)

. Last April, National Semi spent $122 million for network chipmaker

CommCore Semiconductor

. But under National Semi's leadership the network division has missed a key product cycle. In January, CEO Brian Halla took the division under his personal charge.

But Commcore had no track record to speak of, Westmont says. What happened to National Semi shows how murky the waters could be for Intel in the networking arena. "National had it all -- 100% of the market three years ago, but they missed the product transition to more highly integrated chips."

It was at that point, Westmont says, that Level One leapfrogged National Semi to take market away, and someone else can come and do the same again, he said. "The really successful companies have been pure plays, nimble and fast-moving."

While Intel is a great manufacturer, it is not known for speedy development of new products, he says.

This concern wasn't missed by Kevin Landis, portfolio manager with

First Hand Funds

, who has been long both Intel and Level One and expects the deal to lift both stocks. "It's great for people like me who own a lot of Level One," he says.

"The big question for me is whether Intel becomes a bull in the china shop. Intel is not likely to do something small. Up until now the networking market has been a collection of smaller, hungrier companies level-headed about the way they compete," he adds.