Nortel: Lesson In Economic Knock-On Realities

Includes: AIRV, FLEX, NT
by: Dean Bubley

Yesterday, Canadian network equipment maker Nortel (NT) filed for bankruptcy.

I don't want to address the specific factors that have led to its downfall, but rather the possible consequences for the wider industry, which highlight the "interconnectedness" of the telecom sector.

There are lots of direct and indirect consequences:

  • According to Reuters, one of Nortel's main creditors is Flextronics (NASDAQ:FLEX), a contract manufacturer. Its own statement yesterday highlighted that it had been undertaking "risk mitigation" with regard to Nortel for some time. Expect a lot more "risk mitigation" to occur in the industry - requests for cash upfront, reduced payment periods, perhaps leasing rather than sale and so on.
  • "Risk mitigation" is a lot easier for large, diversified suppliers like Flextronics. It will be less obvious what happens to Nortel's other suppliers. There's a good comment on supply-chain fragility here, which talks about the possible impacts on specialist chipmakers. Airvana (AIRV), which has an OEM relationship with Nortel for CDMA equipment, put out its own statement yesterday, referencing unpaid bills. Its shares fell 9% yesterday, against 6% for Flextronics.
  • Personally, I'm thanking good fortune that I don't have any outstanding bills with Nortel, which has been a client in the past. Things are tough enough for small businesses without dealing with bad debts - and it makes me certain to be wary about any other clients that seem to have cashflow issues in future.
  • Irrespective of plans for job cuts, there will be plenty of Nortel CVs out with recruitment consultants. Many suppliers and partners will find that key contacts are no longer in position - adding more friction and uncertainty even where business continues.
  • Its enterprise customers seem sanguine at the moment. Let's see if that attitude lasts if the company's corporate business unit gets sold - perhaps any new future owner will have a different attitude to support or pricing.
  • Nortel has equity stakes in a number of other technology companies. It is possible that these may be sold to realise cash - but at what price? Indian company Sasken, another of Nortel's suppliers, also has the Canadian firm as owner of about 10% of shares. Perhaps in anticipation of a fire-sale of a large chunk of equity, its share price tanked yesterday. Expect analysts to be picking through the shareholder registers of publicly-quoted tech companies in weeks ahead, to see who else is "exposed" in this way. Even for private companies, the anticipation of sales of stakes may negatively impact the valuations of the other owners' shares. Trapeze Networks, for instance, has Nortel, Motorola (MOT) and Juniper (NYSE:JNPR) as investors. If Nortel sells its stake at a discount, Motorola and Juniper's accountants will probably have to reflect a write-down in asset value themselves.
  • This is going to intensify the attitude of operators to restrict their strategic supply contracts to large and well-funded vendors. Mid-sized and startup vendors are going to find it much trickier to cut deals with carriers, and will be forced to approach the "big boys" as OEM partners or channels, or just focus on Tier-2 and Tier-3 customers.
  • Now Nortel has fallen, everyone (especially in the investment world, such as hedge funds) will think "Right. Who's next?". As we saw during the financial crisis last year, this can precipitate the failure of other relatively-healthy companies. It's certainly not going to help anyone looking for credit in the telecom sector.

Overall, it's not good news at all. While at one level, it is going to be necessary for some companies to fail in order to allow the rest of the industry to consolidate and maintain profitability, this is not a panacea. As seen in other industries, the interlinking of supply chains and other relationships has significant knock-on effects.

I'm hoping that the mobile industry doesn't have the sort of dense layout of dominos seen in the finance sector. There is good cashflow coming in at the top, after all. But Nortel provides an object lesson to us.