Nortel to Acquire Bay Networks in $7.27-Billion Deal

Northern Telecom, North America’s No. 2 telephone equipment maker, agreed to buy Bay Networks, the No. 3 maker of networking products, for $7.27 billion in stock.

Santa Clara-based Bay makes equipment that connects computers to corporate networks and the Internet, competing against Cisco Systems Inc. and 3Com Corp. As its larger rivals shipped newer products, sales of Bay’s older gear plunged this year and fierce price competition has cut into its profits.

“There’s a concern [Nortel is] paying a premium for a second-rate company,” said Andrew Martyn, a portfolio manager at the investment management firm Davis-Rea, which owns more than 3 million shares of Nortel’s parent, BCE Inc.

Canada-based Nortel will exchange 0.6 share for each Bay share, valuing Bay at $32 a share based on Nortel’s Monday close of $54 on the New York Stock Exchange. Shares of Nortel--51% owned by BCE, Canada’s biggest telecommunications company--dropped $9.69. That shaved almost $2 billion off the purchase.

After the transaction is completed, BCE’s stake will shrink to 41%, while Bay shareholders will own 21% of the combined company.

Bay Networks shares rose $2.44 to close at $30.75 on the NYSE.

Bay was once the largest maker of networking equipment, yet it began to struggle in 1996 amid intense competition from Cisco and 3Com. Bay briefly reversed its sagging financial fortunes in 1997 with a new computer switch, the 350T, which won a large share of the corporate market, but the turnaround didn’t last.

For its fiscal third quarter ended in March, Bay’s revenue fell 15% to $547.2 million from $644.9 million in the December quarter. Profit before charges slipped to $9.9 million, or 4 cents a diluted share, in the quarter ended March 28, from $20.7 million, or 10 cents, a year earlier.

The transaction caps a month of speculation that Nortel was pursuing Bay.

Once the transaction is complete, the combined company will have a work force of 80,000 and operations in 150 countries. Nortel, like rivals Cisco and Lucent Technologies, wants to sell more gear to phone companies and Internet service providers, who need to expand their networks to handle growing Internet traffic.

John Roth, Nortel’s president and chief executive, will maintain his position. David House, chairman and chief executive of Bay, will become president of Nortel and join its board.