Telecom Sector Slides Further - Good News for Nortel?

Disappointing quarterly results and first quarter guidance from communications equipment maker Ciena Corp. (CIEN) last week appears to be just another sign that the telecom spending market is deteriorating further. While this is clearly bad news for the sector, it might provide some hope for Nortel Networks Corp. (NT) shareholders.

Declining revenue should ease the company’s cash burn, according to National Bank Financial analyst Kris Thompson. He cut his revenue forecast, which now suggests a cash burn of $804-million in 2009, compared with an earlier forecast of $901-million.

The analyst said in a research note:

While this is counter-intuitive, Nortel should benefit from lower working capital requirements (e.g., inventory, receivables) to match a lower revenue base.

However, persistently lower revenue is not good news for Nortel’s ongoing asset sales and would also force the company to make further restructuring changes to boost profitability, he added.

Specifically, Ciena’s outlook is a negative indicator for Nortel’s Metro Ethernet business, Mr. Thompson noted. Although Ciena generates less than half of the revenues of its rival, it is a direct competitor in Carrier Ethernet and Optical transport solutions. “We expect potential suitors of Nortel’s Metro Ethernet will refer to Ciena’s market challenges in negotiating a lower price for Nortel’s assets,” the analyst said.

As a result, he feels there is still no reason to own Nortel shares. Service provider spending could decline more than 10% in 2009, the environment makes divesting assets a challenge, and Nortel faces mounting pension obligations, a high cash burn rate, and fierce competition from both large vendors and low-cost Chinese vendors. He cut his price target in half to $0.25 per share.

As for reports the Nortel is considering bankruptcy protection, Mr. Thompson feels this is premature but noted that capital markets are much different today than in previous downturns.

He said:

Banking industry participants are suggesting that distressed companies are considering pre-emptive bankruptcy protection since debtor-in-possession [DIP] financing is tough to come by in today’s credit market.

This would reduce the interest expense burden before cash balances become so low that avoiding interest expenses would not be adequate to support ongoing operations. Mr. Thompson said this is worth monitoring at Nortel.

The analyst said:

Is Nortel’s fiduciary duty to both equity and bond holders, or do bond holders become a priority when a company is faced with a likely bankruptcy? We don’t recommend shareholders stick around to find out.