A Nortel Postmortem

A friend of mine, whose knowledge of Nortel (NT) and its technology is truly impressive, offered some thoughts about what management and investors should take away from the company’s troubles:

Management Lesson: Evolution Matters

Companies that fail to evolve with their customers’ changing needs or the changes in the industry will suffer a dark Darwinian fate. Nortel was actually very good at evolving and anticipating industry change in the ’70s, ’80s and early ’90s. However, the company failed to address the single dominant change since then - the commoditization of technology brought on by IP technology and the emergence of Chinese competitors. Clearly commoditized pricing trumped so-called superior technology in the eyes of the major telcos of the world.

Investment lessons

1. Cash flow trends do not lie.

Nortel’s cash flow statement showed declining or steeply negative cash from operations for several years. In particular, the so-called turnaround on the income statement (rising gross margins, reduced EPS losses) from 2005-2009 was clearly not represented by cash trends.

Various accounting gimmicks such as deferred revenue, inventory writeoffs and perpetual ‘one-time’ charges painted a picture that was not consistent with reality and obscured Nortel’s declining business.

2. Bond yields do not lie

Since Sept., 2008 the bond yield for Nortel issues soared from distressed levels (1,000 basis points above treasury) to astronomical levels (50%+ yield is too good to be true for very long). Clearly the bond market was signalling very high risk of Nortel’s failure.

3. Management teams do lie, to themselves

Nortel lived in denial of the fundamental negative trends in its business for the past eight years or so. By failing to adequately address the big changes in the industry, Nortel was essentially lying to itself. As a result, the wrong ideas were put forward because Nortel was trying to solve the wrong problems and trying to recreate the successes of the past while ignoring commoditized pricing trends. (i.e. Let’s become more efficient. Let’s crank out a great new optical product. Let’s catch the next wave of wireless technology upgrades, etc.)

Denial is the biggest enemy of big companies and it is equally damaging for Nortel as it is for General Motors (GM), although the rate of decline can vary.

If you’re interested in a good read on Nortel, check out Ernst & Young’s reports, particularly the Monitor’s Reports that lay out Nortel’s history and the reasons it sought bankruptcy protection.

In particular, there are two clauses that capture your attention:

Comments

[fisherman:]

Here we go again. The Company goes bankrupt and common stock holders are told to go to hell--wiped out!!! And why? Because of incompetence,greed and malfeasance. For once, I'd like to see restructuring include preservation of the interests of the common stockholder.I'd like to see a class action filed where we get more than a few bucks back by limiting legal fees and costs so more funds get distributed to the injured stockholders. Dream on!!!

Jan 23 12:00 AM