Nortel's launch pad for faster growth

           
In an industry where mergers and acquisitions of competitors are
commonplace, the combination of Nortel Networks Corp. and PEC Solutions Inc.
raised eyebrows among many industry executives and market analysts.


           
The two seem an unusual match. Nortel is a global telecommunications
equipment manufacturer in

Canada


, while PEC is a 20-year-old, niche IT services provider to the

U.S.


federal government.


           
But the PEC acquisition gives Nortel a platform to expand its business
with the

U.S.


government, a market that is a top priority for Nortel's Vice Chairman and
Chief Executive Officer William Owens, a retired Navy admiral. Last August, he
designated three strategic areas of growth for Nortel: government markets,
security and services. The $448 million deal for PEC was announced in late April
and closed June 7.


           
Nortel "is playing to win," Owens said when the acquisition was
announced.


           
With PEC, "we're going to make better products that are more focused
to the government market, and we'll understand [the market] better because of
the great engineering expertise and the customer relationships that PEC has,"
said Chuck Saffell, CEO of Nortel PEC Solutions Inc., the new unit formed by the
acquisition.


           
PEC's business ? nearly all from the

U.S.


federal government ? pulled in $202.7 million in 2004 revenue, but Nortel
declined to disclose the revenue for the combined

U.S.


government operations of Nortel and PEC.





A new 'in' door


           
The acquisition also gives Nortel, a

Brampton

,
Ontario


, company with 34,150 employees and $9.8 billion in revenue, a way to work
around the restrictions imposed on foreign-owned companies when doing business
with the federal government.


           
Before the acquisition, Nortel had to get a clearance for each sale it
made to

U.S.


government customers. But Nortel PEC Solutions is structured as a wholly owned
subsidiary of Nortel and will have a board of directors that is independent of
the Canadian parent company.


           
It is a structure used by other federal contractors such as BAE Systems
North America Inc. of

Rockville

,
Md.


, and Serco Services Inc. of

Vienna

,
Va.


Both are owned by parent companies in the

United Kingdom


.


           
Nortel PEC Solutions now can compete on equal footing with any other

U.S.


government contractor, Saffell said.


           
With PEC's IT solutions, services and program management support skills
married to Nortel's capabilities in designing, manufacturing and installing
networks and network equipment, the combined companies have a leg up on the
competitors each once faced alone, Saffell said.


           
PEC's business, comprising about 25 percent Defense Department and 75
percent civilian government, will mesh well with Nortel's federal business,
with 25 percent of its work in civilian agencies and 75 percent in defense.


           
"From a business activity, it's a real good fit," Saffell said.


           
PEC counts among its customers the Coast Guard, FBI, Homeland Security
and Justice departments, Postal Service, Secret Service and Transportation
Security Administration. Its recent contracts include a $6 million deal to
provide program management support to an Education Department project for states
to share information on the children of migrant workers.


           
In another project, PEC is providing management services and IT support
to the Justice Department's eWorld project under a $14.1 million contract. The
eWorld project replaces several legacy systems with a new one that manages
immigration case documents.


           
PEC Solutions ranks at No. 66 on the 2005 Washington Technology Top 100
list of the largest government contractors.


           
Nortel offers solutions that integrate switching, IP technologies,
routing, optical, wireline and wireless transmission into converged networks.
Nortel provides a secure voice network for the Defense Department in all 50
states and in more than two dozen countries. About 70 percent of the Air
Force's voice equipment rides on Nortel switches and backbone, Saffell said.


           
While Saffell leads Nortel PEC Solutions, PEC's three founders will
continue to play an important role with the company. Chairman and CEO David
Karlgaard is now vice chairman of Nortel PEC's board of directors, PEC
President Paul Rice is president of the PEC part of the new company, and Chief
Operating Officer Alan Harbitter has taken on the role of chief technology
officer.





Surprise move


           
Although the acquisition, in which it gets a solid foundation in the

U.S.


government market, makes sense for Nortel, PEC's willingness to be acquired
surprised some analysts.


           
Michael Keller, an IT services analyst at KeyBanc Capital Markets of
Cleveland said he didn't expect PEC to be an acquisition target because the
company recently made two deals of its own.


           
In September, PEC acquired AC Technologies Inc. of

Fairfax

,
Va.


, for $46.7 million to boost its capabilities in software engineering and
networking services. In June 2004, PEC bought for $33 million the Denver-based
Integrated Information Technology Corp., which specializes in satellite
communications, network operations and maintenance, and engineering and
installation services. Overall, PEC has made five acquisitions over the last
five years.


           
But the company was at a critical stage, PEC's Karlgaard said. "We
were too big to be considered a small company, and too small to be considered a
big company," he said. Other companies had approached PEC over the years, but
it never found its pursuers to be a good strategic fit, Karlgaard said. Stuck in
the middle market and competing with larger contractors, PEC needed a merger
partner to continue growing and become a significant participant in the federal
market.


           
"Looking forward to continue our thrust to be a serious play in this
market, we felt it was time to step up to a partnership like this," he said.
"This is a perfect strategic fit, the kind that everybody benefits by."


           
PEC's shareholders and clients will get a much stronger company with
Nortel PEC Solutions, and all of PEC's employees will keep their jobs, he
said.


           
Nortel's struggle with the accounting problems that caused it to
restate earnings threw other industry watchers off any scent of the deal, said
Greg Teets, an analyst at A.G. Edwards & Sons Inc.,

St. Louis


. Nortel still must overcome the stigma from the restatements, which left
investors and others feeling the company was "unstable and not steady on its
feet," he said.





Management discord


           
Concern over the Canadian company had been fueled further by recent top
management upheaval at Nortel, when president and COO Gary Daichendt resigned
over management differences with CEO Bill Owens, and CTO Gary Kunis also quit,
Teets said.


           
But Nortel PEC's Saffell dismissed such concerns and said the
management changes wouldn't strain integration of Nortel's federal unit with
PEC.


    Although
he didn't rule out more acquisitions, Saffell said the top priority will be to
integrate the two businesses. Because the two companies had such different lines
of business, all of PEC Solutions has been kept intact, including support
services such as human resources and payroll. Nortel PEC Solutions needs that
infrastructure to operate as an independent company, he said.


           
"There's essentially no part of PEC that we don't want," he said. 



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