GEC mounts net offensive

By swooping on a US technology firm, the one-time defence giant could become a force on the internet. Peter Koenig reports

Where, Peter Mandelson asked during his stint as secretary of state for trade and industry, were Britain's Microsofts, its Intels, its Ciscos? Where, indeed, were its Bill Gateses? Well, now he has a belated answer.

With the announcement last Monday of its intent to buy Fore Systems, of Warrendale, Pennsylvania, for $4.2bn (pounds 2.6bn), General Electric (GEC) emerges from virtually a half century of decline and months of doubts about its latest restructuring. With this news it establishes itself as a credible candidate for becoming the leading internet stock in the UK.

Lord Simpson is emerging as our putative Bill Gates. "My vision is to move the company from what it's been - a disparate conglomerate made up of lots of separate pieces - into a focused, high-technology company concentrating on communications," GEC's chief executive says.

The City, of course, loved the deal. The day after its ann- ouncement, GEC shares soared 8.5 per cent, the best performance of any FT-SE 350 company. The Government loved the deal so much that it is now almost certain that the Office of Fair Trading will not block a crucial bit of GEC restructuring - its sale of Marconi defence electronics to British Aerospace for pounds 7.7bn - out of respect for Lord Simpson's bold plan.

High-powered competitors paid their respects. "It's a heck of a buy," says Cisco Europe chief, James Richardson.

British analysts who have grown white hairs over the botching of GEC's efforts at modernisation since 1980 - especially in contrast to the astonishing renaissance of General Electric of America under chief executive Jack Welch - celebrated.

"I'm pleased," said Chris Lewis, director of Euroscope, Yankee Group Europe's strategic planning unit. "It brings a British company back into the telecommunications mainstream."

Actually, it does even more. It guarantees GEC's escape from the killing fields occupied by passe engineering conglomerates. It gives the venerable UK company a shot at becoming a hot internet stock.

Semi-conductors in the 1970s; software in the 1980s; the internet in the 1990s. Once in each decade a new technology emerges from the undergrowth of commercial activity to capture the world's imagination. The ensuing frenzy, of course, is overblown, but the revolution in information technology is real.

Currently capturing the headlines in the internet boom are companies such as Dixons, which has raced ahead to become the early leader in the setting up of cyber shopping malls. Wall Street punters have a high opinion of Amazon.com and other high-profile net retailers. Institutional investors also like Microsoft, BSkyB, and other companies that are well positioned for the convergence of the computing and entertainment industries.

The real winners so far, however, have been in telecommunications: companies like BT and MCI WorldCom which sell access to the internet, but also companies like Lucent Technologies and Cisco which sell the equipment which is now being dug into the ground and installed in windowless rooms.

The internet boom is being fuelled by technological innovation. Huge volumes of data can now be transmitted, so individuals can download Freeserve and Yahoo! web pages, and companies can shuttle their corporate accounts from city to city.

The boom is also being fuelled by deregulation. Voice carried over the internet - just now coming into its own - is unregulated. These calls crossing any national boundary can be priced dirt cheap, compared to traditional calls.

Emerging global "mega-carriers" are expected to invest $100bn in new equipment by 2001, according to Lucent. There will be 1,000 new internet carriers by 2000. There were 3,400 billion e-mail messages sent last year, it says.

This makes the telecoms equipment market one of the most exciting in the world. Now about 15 years old, it is just beginning to consolidate. America's Lucent and Cisco and Canada's Nortel stand at the top of the tree, while European competitors are struggling. Sweden's Ericsson has reported disappointing results. Alcatel is felt to have no clear strategy.

Germany's Siemens is in better shape. It is trying to transform itself from an old-world into new-world engineering company without making big internet acquisitions. "In March we founded a new company in the US called Unisphere Solutions," says company spokesman Rainer Schoenrock. Siemens is folding its internet units into this new company in what it sees as the "driving market" for the boom.

Until January, GEC was almost nowhere in this equation. Its Marconi Communications division was a leader in the SDH technology used to transmit voice down copper by encoding voice frequencies into 364 bits, then decoding the electronic impulses at the other end of the line. But this is old-world technology and GEC's global sale of it depended on a joint venture with Siemens which is now being disbanded.

Then on 19 January, GEC and BAe announced their defence deal. "We're driven by shareholder value," says Lord simpson. "But this was a good deal for the country. It created a global defence company everyone in the world must now reckon with. It put us on the path to being a global hi-tech company."

Three months later, GEC bought its first new-age telecoms equipment maker, Reltec - based in Cleveland, Ohio - from the US leveraged buy-out specialists Kohlberg, Kravis & Roberts, for $2.1bn. Reltec makes high-speed, high- capacity technology used in the last mile of linking the internet to customers. Then, two weeks ago, Lord Simpson and GEC finance director John Mayo flew to the US and sealed the Fore deal. "Reltec happened because we know Henry Kravis very well," Lord Simpson says.

"Fore was different. We could see [acquisition] candidates being picked off: Xylan, Ascend. We identified Fore. John Mayo put the deal together in six weeks. It was a skilful negotiation."

GEC has made the most of the Fore deal in terms of publicity. The US company's technology, the company says in a press release, "will enable Marconi Communications to establish a leadership position in defining and building new public network infrastructures and solutions".

Note the careful wording, however. Leadership position, Lord Simpson says, is defined "in terms of products. It doesn't mean we're biggest or best."

Fore is a leader in ATM technology - switches that allow electronic packages to be routed round the web and phone system quicker, more cheaply and in more complex combinations.

"ATM is important," says Frank Pipe, managing director of Lucent UK. "But it's only one bit of the puzzle." In the end, customers want total solutions, he adds.

GEC is, in other words, still small fry compared to Lucent. Its turnover for the six months ending 30 September was pounds 3.4bn, compared to Lucent's pounds 5.1bn for the three months ending 31 March. GEC's research and development comes to about pounds 1bn a year; Lucent's more than pounds 10bn.

Lord Simpson acknowledges his David v Goliath role, but says GEC will build momentum through cross-selling Marconi, Reltec and Fore products. Can GEC build enough momentum to become a credible high-growth internet stock?

"[Turnover in] Reltec and Fore is growing at 30 per cent to 35 per cent a year," he replies. "I have to believe as chief executive that with new products and salesmen from Marconi, we can drive up that rate of growth."

CCF Charterhouse analyst Michael Blogg endorses this bullish view. "Compared to Ericsson and Alcatel, GEC has less drag on it, [from old business units]," he says. "When you compare GEC to Lucent and Cisco, it becomes a valuation question. GEC is selling at 20 times earnings, Cisco 40 times."

Asked to characterise conclusively where GEC stands in the information age, Lord Simpson is cautious. "We now have the technology and product footprint to be a major player in the global telecoms business," he says. "Does that mean we can compete head-on with Lucent? No. Lucent is much bigger. But it means we have the same technology. We have a platform to build on."

Will GEC execute on this plan? "I'll answer this way," says Yankee Group's Lewis. "In order to compete successfully, GEC needs to learn the lessons of Lucent, Cisco, and Nortel. This is a market of big, aggressive players; GEC must build a strong brand quickly."

Doing this will not be easy. GEC is neither giant nor start-up. It is seeking the corporate version of a second coming. Lord Simpson and his management team have done an excellent job. But the hard part has just begun.

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