Nortel Networks: A History of Failure

Yesterday's Lex column in the Financial TImes recommended that investors get their feet wet with regard to Nortel Networks (NT). I respect the Lex authors a great deal, and their analysis is always based on thorough and excellent research, and often have insights that baffle me, and has me nodding in agreement. But this time around, I disagree.

Back in the 90s, NT was called Northern Telecom, and they were a dividend paying, boring company, that did well for a lot of Canadian retirees.

In 1998, they acquired Bay Networks [Bay Networks was then the newly merged WellFleet/SynOptics] for $9 billion in NT stock, and re-christened themselves Nortel Networks.

As the stock was bid through the roof, the dividend was no big deal, and represented a very minute % of the stock's quotation. Y2K was great for NT. Their sales topped $30 billion, with healthy gross and net margins, and their market value hit a high of almost $400 billion [CDN].

Then came a disappointing series of events. The average selling prices of NT's equipment dropped, the massive dark and lit fiber build-out ceased, and NT started losing money. NT tried to save money by killing the dividend in 2001. But things went from bad to worse, and CEO John Roth was asked to decide to spend more time with his family and the CFO Frank Dunn succeeded Roth. Things got even worse and before long, Dunn was done, too [sorry - bad pun]. It seemed that about $3 billion in revenues from 1998 to 2000 was moved to 2001, 2002 and 2003 and about a quarter billion vaporized. Apart from SEC lawsuits/investigations and restatement of numbers, Dunn & Co. were charged by the RCMP recently.

Anyway, from Roth through Dunn, NT's management did not deliver. They took a $19 billion write-down in assets [mostly goodwill from acquisitions] in 2001, and warned that they would restate earnings. The stock followed south from a high in the $800's [split adjusted] to about $20, when the company did a 1 for 10 reverse split [the $800 would be $80 and $20 would be $2 without the 1 for 10 reverse in Dec 2006].

In 2004, a new clean-up CEO Mike Zafirowski took the helm from Dunn. He sold non-core assets, and has done his best to keep the divisions in synch.

Looking at NT's current 10Q for the quarter ending June 30, 2008, they have $2.8 billion in deferred taxes as an asset. Looking back from 2007 to 2008, NT had $2.868 billion in deferred taxes in 2007. On June 30, 2008, the deferred tax number is $2.809 billion. Which means that they used $59 million. At this rate, it will take NT 46 years to "use" this asset. So, I am going out on a limb and saying that this asset is worthless.

The bottom-line:

1.  I [in a rare act of dissent] - disagree with Lex.
2. NT is not a good investment at any price - given their record of not being able to do what they promise to do.
3. Strange items on the 10Q like the deferred tax assets which will take 46 years to use [I am not an accountant, so I expect to be corrected regarding the "use" of this asset].
4. NT possesses no real competitive advantage in the Telecom Equipment space.
5. In my opinion, no stock is worth buying just because it is cheap. It needs to be cheap and have a viable business with good numbers [like good cash flow, FCF] for me to buy into the stock.

Disclosures: I have no position[s] in NT - nor do I plan to initiate any.

Comments

[Robespierre:]

So you are not an accountant as you indicated, by your comments on competitive advantage I can see you are not an engineer and you have or plan to have a position on NT (long or short). So tell me again how do you make a living? History teacher?

2008 Aug 05 08:34 AM

[exnt:]

You are largely correct about Nortel's position, although you let them off the hook on all the scandals, lawsuits, and failed new products like wimax, IPTV, IMS, etc.

2008 Aug 05 10:09 AM

[LeeWillcox:]

They replace a thief with another thief then replace hum with CEO Mike Zafirowski, a man who hires all his friends. He even had to make up jobs to get them all in. All the profit goes out in the door in bonus's and options and you wonder why the company is going broke?
True the company is broke but Mike and friends aren't!

2008 Aug 05 10:23 AM

[Bapcha's St...:]

I am an engineer trained by Henry Samueli at BRCM [before his felonies] with nearly 2 decades in the Si valley, so I CAN comment on whether NT's products are competitive or not.

Bapcha
bapcha.blogspot.com

2008 Aug 05 10:57 AM

[roshpina:]

Bapcha,

Too bad you did not do a dedicated and complete analysis and study of Nortel history and products portfolio. I’ll mention only two out of several mistakes you have made:

1) You wrote: “In 2004, a new clean-up CEO Mike Zafirowski took the helm from Dunn.”

Sorry dude. Wrong! Didn’t you hear about Bill Owans (the # 2 in the USA army chain of command)? He took over from Dunn, not Mike Z. Please get your history corrected.

2. You wrote: “NT possesses no real competitive advantage in the Telecom Equipment space.”

Again genius, didn’t you hear about the 40G and 100G new products from Nortel that so many technical editors put on a pedestal?

Achieving a speed of 40G to 100G at a very low cost without having to replace your network??? Didn’t you hear about the multiple new customers Nortel had for this new tech product of theirs in a very short time since it was recently introduced?

And didn’t you hear about the industry-leader - Nortel (based on independent reviews) in energy saving products?

"NT possesses no real competitive advantage in the Telecom Equipment space” ??? Baa humbug!!!

Bapcha you neither know the company's history nor it’s up-to-date technology. Suggest you remake your homework and think again about your disagreement with Yesterday's Lex column in the Financial Times recommending that investors get their feet wet with regard to Nortel Networks (NT). Looks to me like Mr. Lex knows much more than you do concerning Nortel.

JMHO,

Maximus

2008 Aug 05 12:07 PM

[longoil:]

Nortel is the reason I am completely out of tech stocks and invested in "safer" things like oil and gas.

This is a loser company with no future.
Just look at all the market segments they are involved in:

1) Enterprise & Data Networks: The took a company (Bay Networks) with a 15% market share and decimated it completely in 1999. Cisco rules this market segment and always will.

2) Optical: They are betting the future on 40g and 100g equipment. How many units do you think they will sell, before the Chinese (aka Huawei and ZTE) take over and commoditize this market segment entirely like the did for OC48 and OC192 equipment ?

3) Broadband: They missed the boat on this one completely. They sell off the broadband division in 2001 and bet the future on optical equipment. They have no broadband products; a market segment with hundreds of millions users. Cisco (via Scientific Atlanta), Alcatel-Lucent and Nokia-Siemens all have a major presence in broadband.

4) Wireless: They guys are still manufacturing CDMA equipment.
The world has moved to GSM and LTE.

The future of high tech is wireless and broadband. Nortel is not a major player in either market segment.

2008 Aug 06 12:45 PM