NORTELS $7.6B PURCHASE OF BAY SHOWS LURE OF IP-NET SOLUTIONS

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Nortel last week responded to surging demand for
carrier-class IP-networking (Internet-protocol) solutions by agreeing to purchase Bay
Networks Inc.

This marks the biggest step yet taken in this direction by
a major telecommunications-system supplier.

Along with providing Nortel with a pool of expertise to use
in quickly driving new products to market for telcos, the move puts the muscle of a $15
billion telecommunications supplier behind Bay's efforts to expand its data-modem
business in cable.

"The union with Nortel greatly expands our
opportunities to supply system solutions to the cable industry as it continues to
evolve," said Karl May, vice president and general manager of broadband technology at
Bay.

Nortel was not alone in finding an ally to support the
development of integrated router/switches and the supporting software systems that
networks like the one that Sprint Corp. announced two weeks ago will require.

Other top telecommunications vendors have announced
alliances with data-communications firms:

• Siemens AG aligned with 3Com Corp. to develop
central-office switches with IP-voice gateways built in.

• Ericsson Inc. took a significant stake in start-up
Mariposa Technology Inc. to incorporate that company's intelligent-voice/data-access
solutions over ATM (asynchronous transfer mode) into Ericsson's core products.

• Alcatel Telecom Inc. allied with Cisco Systems Inc.
to become the first telecommunications supplier to offer gear supporting Cisco's
version of the emerging IP-over-ATM standard known as MPLS (multiprotocol layer
switching).

While all of those companies are playing to different
strengths in these alliances, the primary goal in each case is to provide a bridge between
traditional switching and the IP domain. That way, carriers can begin adding voice to the
data-transport side of their networks, eventually eliminating circuit-switched voice
altogether.

But none of these deals is as closely tied to cable's
advanced-networking requirements as the Nortel/Bay merger.

"We knew that we'd have to partner with a company
like Nortel to provide what our customers require as the service requirements move from
high-speed Internet access to much more complex uses of IP technology," May said.

Even before the two companies generate new products, the
combination will allow Bay to compete for systems-integration business, extending beyond
modem and headend gear, that Bay would not have been able to compete for on its own, he
added.

May maintained that synergies were possible because of the
"tremendous overlap" between the two companies. For example, he noted, Cox
Communications Inc. is deploying Nortel switches and Bay modems in some markets, and it is
also using the voice-over-cable technology supplied by Arris Interactive, the joint
venture between Nortel and Antec Corp.

Rather than seeing the proprietary Arris system as a
competitor to the type of IP-voice products that Bay might generate for cable, the
companies viewed their respective technologies as complementary, with long-term potential
for integration into next-generation systems, May said.

Although cable is moving in the direction of using
voice-over-IP on a wide scale, he added, IP telephony still falls short of the performance
standards that have been set by today's circuit-switched POTS (plain old telephone
service).

IP falls short on both quality and on such issues as
back-office management and billing support and the ability to exploit the capabilities of
intelligent-network technology, such as call forwarding, caller ID, 800-number service and
much more.

"These are the areas of expertise that Nortel adds,
which gives us the ability to develop carrier-class IP-telecommunications solutions for
cable, as well as for other types of customers," May said.

Moreover, he noted, Nortel brings its position as a
market-leader in fiber-network systems to the table, opening new opportunities for the two
companies to develop IP-over-fiber solutions that are suited to the evolving architectures
of cable-data networks.

Bay is looking at approaches to expanding the functionality
of layer 3 IP routing in optical networks that would go beyond other new approaches to
using wave-division multiplexing to carry data traffic, such as IP over SONET (synchronous
optical network) and IP over ATM without SONET, May said.

While declining to discuss details, he acknowledged that
this approach has special appeal to the cable industry. Layer 3 control over the optical
layers would considerably reduce cable's bandwidth overhead and the hardware costs of
using either SONET or ATM technology.

Nortel's costly acquisition of Bay came in a stock
transfer valued at $7.68 billion, representing a 14 percent premium over Bay's
public-market value when the deal was announced.

It reflects a conviction that the market will require
carrier-class IP solutions on a much more vast scale and much sooner than once seemed
likely, said Klaus Buechner, senior vice president of corporate strategy at Nortel.

"Our view is that IP will dominate not only Internet
and private data-networking solutions, but all network communications," Buechner
said.

Buechner declined to comment on Wall Street concerns over
the amount that Nortel is paying for Bay, which were reflected in a 15 percent overnight
plunge in Nortel's stock price after the announcement last Monday. But he stressed
the value to Nortel that comes with having the ability to respond to market developments
in the enterprise arena served by Bay, where innovations defining the evolutionary path
for IP tend to occur.

"The routing world is now dominated by Cisco, which,
to put it diplomatically, uses code that sometimes has inconsistencies with the standards
used in IP networks," Buechner said. "Bay has the expertise to help us work
around those inconsistencies to supply more reliable products that fit the needs of large
carriers."

Ericsson -- which partnered with Bay in advance of the
Nortel announcement to develop an integrated ATM/IP solution using MPLS technology, which
is now in production -- chose Mariposa because it offers technology that condenses ATM
switching and backbone-router technology into compact, low-cost units that large
enterprises can use to integrate voice and data traffic before sending it out over
external networks.

"We're not going inside the enterprise space, but
we're improving our position at the edge," said Anders Igel, executive vice
president and head of Ericsson's Business Area Infocom Systems unit.

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