Yesterday, telecommunications and network equipment company Ciena Corporation (CIEN) announced the acquisition of substantially all of the optical networking and carrier Ethernet assets of its rival Nortel Networks’ (NT) Metro Ethernet Networks (MEN) division, for a total of $521 million ($390 million in cash and 10 million in shares worth $131 million based on the Oct. 6 market price).

Ciena will take over Nortel’s long-haul optical transport portfolio, metro optical Ethernet switching and transport solutions, Ethernet transport, aggregation and switching technology, multiservice SONET/SDH product families and network management software products.

Moreover, Ciena expects to incur integration-related costs of approximately $180 million, the majority of which will be paid in 2010 and expects the transaction to be significantly accretive in fiscal 2011.

Nortel had filed for bankruptcy protection back in January in Canada, and has since then planned to sell off its assets. Nortel had sold its wireless carrier business to Sweden’s Ericsson (ERIC) for $1.13 billion in July. This was followed by the sale of its Enterprise unit to Avaya for $915 million.

Ciena is expected to employ at least 2,000, or 85% of Nortel employees. The acquisition would significantly enhance Ciena’s existing Canadian development resources, making Ottawa the company’s largest product and development center. Deutsche Bank Securities Inc. and Foros Securities LLC served as financial advisors in the deal.

Ciena’s Carrier Ethernet platform enables differentiation and provides a competitive advantage to the company. We believe the deal could provide strong growth potential to Ciena’s rapidly expanding metro Ethernet business and optical networking products.

For the third quarter, Ciena generated approximately 14% of total revenue from metro Ethernet products. The company expects the Ethernet division to be a major contributor to growth, going forward. Besides, the merger could double Ciena’s revenue. Ciena had total revenue of f $902 million in 2008, while Nortel’s Ethernet business generated $1.36 billion in revenue in 2008 and $556 million in the first six months of 2009.

Moreover, the acquisition would provide tough competition to other players in the networking industry such as Ericsson, Nokia (NOK) and Siemens (SI). Longer-term, we view the deal to be positive for Ciena.

However, Ciena is a small player with minimal revenues. Therefore, Ciena could face integration problems. For example, Nortel had $10.4 billion in 2008 revenue compared to Ciena’s $902.5 million. Moreover their products overlap and may affect Ciena’s Ethernet business in future quarters.

Second, we believe that the deal could pull Ciena into a net debt (debt exceeding cash) position. The company exited the most recent quarter (second quarter) with $1.07 billion in cash, short-term investments and long term investments and had $798.0 million in long term debt (convertible notes payable). Moreover, risk of dilution remains.

Ciena said that the agreement is subject to a competitive bidding process under the United States Bankruptcy Code and the Canadian Companies’ Creditors Arrangement Act. The deal is subject to approval of courts in Delaware and Ontario.

Intense competition from companies such as Alcatel-Lucent (ALU), Cisco Systems (CSCO) and Tellabs (TLAB) is eating into the company’s market share. However, we do expect a recovery in 2010 due to operational execution and growth in data traffic.

We have a Neutral rating on the stock.

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