Alcatel to Buy Xylan in Data Network Deal

Xylan, the Calabasas company that makes computer networking switches, will be acquired by French telecom giant Alcatel in a $2-billion cash deal that underscores the unrelenting demand for networks designed to carry both voice and data traffic.

The $37-per-share offer announced Tuesday represents a 76% premium over Xylan’s share price of $19.88 last week, before merger rumors began pushing its stock up. Xylan shares soared $8.81--or 33%--to close at $35.75 Tuesday in extremely heavy Nasdaq trading.

Companies such as Xylan that specialize in making switching gear for data networks have become popular targets for telecommunications equipment manufacturers over the last year, as increased Internet use has spurred demand for technology to dispatch data. Alcatel rivals Lucent Technologies and Nortel Networks have each purchased data-switching companies since last summer.

Those deals forced Xylan to look for a merger partner of its own, analysts said. Alcatel already owns 5% of Xylan, and the two companies have been partners since 1995.

“Alcatel is clearly the most logical partner,” said Scott Heritage, a senior analyst with Warburg Dillon Read in New York. “It’s a great fit.”

Xylan will fill a major gap in Alcatel’s product line, which is weighted toward traditional voice-switching products, analysts said. Alcatel’s U.S.-traded shares rose 50 cents to $21.88 on the New York Stock Exchange. Alcatel has slumped from a high of $47.13 last year.

Xylan will remain in Calabasas--where 600 of the company’s 1,100 employees are based--and operate as a wholly owned subsidiary of Paris-based Alcatel. Once the deal is completed in early April, Alcatel’s worldwide sales-and-marketing machine is expected to triple Xylan’s annual sales from $348 million in 1998 to $1 billion in 2000, the companies said.

Although its products have won praise from customers--including IBM, Lockheed Martin and the U.S. military--Xylan didn’t have the resources to sell as aggressively as its larger rivals like Cisco Systems, 3Com, Nortel and Lucent, said Steve Kim, Xylan’s founder, president and chief executive.

“With the merger, we can compete with the Ciscos and the Lucents on equal terms, which really makes this exciting,” Kim said.

Six-year-old Xylan has enjoyed a good reputation in the telecommunications industry since it began selling data switches in 1995. Xylan’s sales have grown steadily from $30 million in 1995 to $348 million last year. Earnings have also been rising, from $15 million in 1996 to $39 million last year.

When the company went public in March 1996, its shares rocketed from $26 to $58.38 in their first day of trading and reached an all-time high of $76 a few months later. But for the last two years, the company’s stock has mostly languished in the $20 range, hitting a low of $9.63 in September.

Kim said he has been frustrated that he “couldn’t increase our shareholder value at all,” despite boosting revenue 65% two years in a row. Based on his belief that investors feared Xylan couldn’t survive as a stand-alone company, Kim decided to sell it, he said.

Including shares held in a trust for his children, Kim holds about 3.2 million Xylan shares, according to the most recent proxy statement filed last April. That would make Kim’s stake in the company worth about $118 million, based on the deal’s $37-per-share price.

Xylan’s fate was sealed by the string of deals that saw the traditional telecom equipment leaders buying upstarts who specialized in gear for data networks, analysts said. Canada’s Northern Telecom bought Bay Networks for $7 billion last summer to create Nortel Networks, and Lucent agreed to acquire Ascend Communications in January for $20.3 billion.

“Xylan is surrounded by giants,” said John Armstrong, vice president for networking at market research firm Dataquest in San Jose.

Now, Fore Systems in the Pittsburgh suburb of Warrendale and Newbridge Networks in Ontario, Canada, are the only small players remaining, Armstrong said.