Will Downsizing Help Nortel's 'Tenuous Position'?

Nortel Networks Corp. (NT) may announce a workforce reduction of 10% or more, which equates to at least 3,000 employees, when it reports third quarter results on Monday, Nov. 10. Further restructuring was somewhat implied in the company’s long-term plan, according to Nikos Theodosopoulos at UBS Securities.

This downsizing and the sale of its Metro Ethernet Networks (MEN) division, which was announced in mid-September, could help the company’s worsening liquidity position, the analyst noted.

UBS estimates a cash burn of $686 million in 2008, and $700 million in both 2009 and 2010. This would put Nortel in a “tenuous position” with $1.0 billion of debt due July 2011. At the same time, the forecasted cash burn would yield cash of $1.3 billion at the end of 2010, assuming MEN is sold for at least $500 million.

However, downsizing and a sale of MEN could improve this cash balance by roughly $800 million, bringing it to $2.1 billion, Mr. Theodosopoulos estimated. But there is a risk that Nortel’s revenues fall more than expected as a result of these major staff reductions. It needs to maintain a strong cash position to help it hold on to its debt rating. Deteriorating market conditions and the negative impact this has on its pension obligations could also put more pressure on Nortel's balance sheet.

“We believe the difficult credit markets and slowing capital spending trends will make it more difficult to sell this business than Nortel originally expected,” he said in a research note. “Another factor may be companies less willing to add headcount in this environment, with broad based customer spending weakness.”

He has a “neutral” rating on the stock and a $1.30 price target. 

Scotia Capital’s Gus Papageorgiou also expects Nortel to announce significant restructuring initiatives along with repositioning its market and portfolio strategy. As a result, he recommends investors avoid the stock. The analyst rates Nortel at “sector underperform” with a C$2.60 price target.

He also has doubts about the MEN sale. “Although we believe more than 30 entities have expressed interest in the company’s Metro Ethernet Networks unit, we expect it will be difficult for Nortel to get a cash-deal done, at its desired price, until the macro environment stabilizes,” Mr. Papageorgiou told clients.

While some of the interested parties are private equity firms with access to cash, the analyst believes customers for Nortel’s Carrier business may prefer non-private equity buyer for MEN. “There is also a good possibility of a deal not happening at all,” he said, citing a recent decision from China’s Huawei Technologies Co. to postpone the sale of its handset unit.

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