Nortel: Time To Consolidate and Go After Cisco?

| About: Nortel Networks (NT)
This article is now exclusive for PRO subscribers.

Over the recent years, the increasing use of mobile video, high definition television, video on demand, peer-to-peer connectivity and other web-based, network-aware applications has seen a dramatic increase in the demand for more bandwidth. One network player that aims to capitalize on this trend is Nortel (NT).

In my earlier posts on online video beneficiaries, I have examined Cisco, 3com, Polycom, and Extreme.

Nortel Networks Corporation with revenues of $11.4 billion in 2006 is a global supplier of networking solutions to both service providers and enterprises. It is a leader in delivering VoIP and Wide Area Networking to carrier customers, holds the number-two position in providing carriers with optical equipment, is the number-one provider of total enterprise telephony lines, and is the second-largest provider of IP business telephony. Its business is organized in four segments: Carrier Networks [CN], Enterprise Solutions [ES] Global Services [GS], and Metro Ethernet Networks [MEN].

Nortel anticipates increase in demand for wireless networking solutions due to network traffic growth to support applications such as mobile video. To cater to this demand, it plans to increase its investment in metro Ethernet to support video delivery over wired as well as wireless access and in next generation products. To capitalize on the trend towards IP converged networks, it is trying to focus on the enterprise market and strengthen its end-to-end convergence solutions.

In 2006, it acquired Tasman Networks to strengthen its data networking portfolio and formed a strategic alliance with Microsoft to accelerate availability of unified communications. In 2005, it formed a joint venture with LG Electronics. In March this year, it announced that it would offer its own set-top box to carriers as part of its IPTV strategy. The set top boxes would be manufactured by its LG-Nortel joint venture.

In May 2007, Nortel announced its Nortel Hosted Solutions for enterprises and service providers. The portfolio, with a strong focus on the enterprise segment includes IP telephony, unified communications, automatic call distribution [ACD], contact centers and other network application services delivered to enterprises through service providers using equipment owned and managed by Nortel. It has also entered into an agreement with Polycom to jointly deliver telepresence and high definition [HD] video conferencing solutions to enterprises.

On the financial front, Nortel reported revenues of $2.56 billion in Q2 2007, a decrease of 8% compared to Q2 2006. Revenues decreased in the CN, MEN and GS segments, partially offset by an increase in the ES segment. The decline in revenue was mainly due to UMTS Access divestiture in 2006. It also reported net loss of $37 million compared to earnings of $342 million in Q2 2006. In Q1 2007, Nortel announced its 2007 Restructuring Plan which would reduce its workforce by 2,900 employees and shift approximately 1,000 positions from higher-cost to lower-cost locations. This plan is expected to save $400 million annually.

Nortel’s market cap is $7.47 billion, well below its annual revenue number. Its stock is on a downward trend since February this year when it had reached a high of $31.6. It is currently hovering around $17.

As the online video driven networking equipment market momentum marches on, a distinct possibility is that Cisco’s (NASDAQ:CSCO) competitors would consolidate as a combined force. Today, the networking industry is represented as Cisco and the Seven Dwarfs. Well, if at least 3-4 of the dwarfs get together, the chances of actually being able to compete in specific markets would become higher. In fact, the combination of Nortel, 3Com (COMS) and Polycom (NASDAQ:PLCM) would create more efficient industry dynamics, whereby, rather than also having to compete amongst each other, they can focus their combined energy on competing with Cisco.

It would also create a larger entity (although still only one-third the size of Cisco) that has product offerings in most of the important segments on the networking market, from Carriers, to Enterprise, to SME. The missing pieces need to be brought together from the other dwarfs, some of which we will explore this week.

In the meantime, Nortel, like 3Com, needs to continue cleaning up its house.