This article was originally published in Maclean's Magazine on November 11, 2002
Nortel Struggles to Recover Its Worth
WHEN NORTEL Networks Corp.'s share price was $92 two years ago, Ray Puhalski bought 300 shares, investing $27,600. A month later, the stock was trading at $71.40. Puhalski invested again: $32,130 for 450 shares; and the following week, when Nortel was at $65.50, he bought another 250 shares. Today, Puhalski's total $76,105 investment in the one-time tech giant is worth around $1,900. The retired businessman, living in Stoney Creek, Ont., lays much of the blame at the door of Nortel's former CEO, John Roth. "In my circle of friends," says Puhalski, 58, "his name is mud."
Still, in recent weeks, after months of cascading share prices and mass layoffs, there have been glimmers of good news coming from the telecom equipment maker. Contracts in China; better-than-expected - or rather, not as bad as anticipated - quarterly results; an important vote of confidence from U.S. phone company and key client SBC Communications Inc., which said it's "imperative" that Nortel remain solvent and survive; and a pledge that the company will turn a profit by mid-2003 from Nortel's CEO of the past 12 months, Frank Dunn. There's been a refreshing rise in the company's share price, too, as Nortel's stock has more than doubled in a few scant weeks. But mind you, twice its recent low of 67 cents is a still a far cry from Nortel's historic high of $124.50.
The question is still the same for investors: is Nortel out of the woods? The answer, unfortunately, is probably not. Nortel's problems, the analysts point out, are not unique to the Brampton, Ont.-based company. The rapid expansion of the TELECOM industry, fuelled through the late '90s by dirt-cheap capital, has ground to an ugly halt. Too many fast deals were struck, too much optical fibre was laid, and too many switches produced. In short, there exists too much capacity for telecommunication networks. And Nortel's main customer base, the phone companies and other telecom carriers, is itself in a breathtaking decline - and not in a position to start buying again. Nortel and its chief rivals, U.S.-based Lucent Technologies Inc. and Cisco Systems Inc., are all hurting, badly. As Robert McWhirter, manager of Canada's best-performing tech equities fund, puts it, "The Slim-Fast diet plan is global."
The pound-shedding has resulted in dramatic layoff numbers. Since its peak in early 2000 of 86,000 employees, Nortel has hacked away nearly two-thirds of its staff. Its readiness to hand out the pink slips is "one of the bright spots," says RBC Dominion Securities Inc. analyst John Wilson, who acknowledges the irony. Nortel has moved more quickly and more consistently to unload workers than its competitors, Wilson says, "and that has proven to be the right strategy." Wilson, a Nortel engineer until 1996 (no, he wasn't laid off), says it's impossible to get rid of such large numbers of people and do it well - but there are degrees of how poorly it can be handled. Nortel, a victim of earlier droughts, had experience in cutting staff. "They're actually pretty good at it," Wilson says. "It's an awful thing to say, but that will be a strength for Nortel."
Nortel's acute downsizing is a key reason its chief executive believes the company is half a year away from breaking its money-losing streak, which has dragged on for 11 quarters, or almost three years, and has set off questions about the company's solvency. Dunn, the former chief financial officer who took over in November, 2001 after a long search post-Roth, responded vigorously last month to an employee's internal e-mail. "Hey Frank," the unnamed staffer wrote, "we don't seem to be getting the credit we deserve for all the hard work and progress we've made during the last year. It's frustrating and demoralizing." In a reply replete with words like "resolve," "confidence" and "the will to win," Dunn told employees company-wide that his top priority is to return Nortel to profitability before the end of June. "Let me assure you," Dunn wrote, "our business model is positioned for success, not bankruptcy."
While not giving up on its optical or other principal endeavours, Nortel is bringing to the fore an old line: what's known as the enterprise business. It is aiming to sell a single Internet-based system, replacing or augmenting both phone and computer networks, to large corporations - the original clientele for its early phone products. This new networking gear transmits, super-efficiently, both voice and other data at the same time. It uses what are called packets: rather than a steady stream of analogue signals - as with most conversations down a phone line - digital data, including voice, will be grouped in chunks, along networks that can handle complex series of chunks at a time. In his e-mail to employees, Dunn was keen about this: "Make no mistake," he said, "being a key player in this transformation is a big opportunity for us." At the office, the change would be significant: instead of having one telephone designated to each employee at each desk, a firm could have staff dial into a central system from any phone in the company and make that phone their own, at any time, complete with their own phone number and voice mail. The phone screen could show caller lists, news headlines, company info - even Nortel's stock price. For corporations, the cost would be much less than maintaining a series of existing networks.
IDC Canada Ltd., a Toronto-based research firm, predicts the market for voice over the Internet, known as VoIP, could jump to 60 per cent of the world's telephone voice traffic by 2007, up from five per cent last year. By then, says IDC, the US$2.7 billion market could be worth $40 billion. For Nortel, targeting enterprise is a lot like going back to an old strategy. Nortel was a supplier of Meridian phones, a staple in offices across Canada and elsewhere. And it was a key vendor of corporations' internal PBX telephone switchboard systems. Nortel's advantage on this front is that its new packet-based equipment meshes with the older one. But it is up against its arch rival, San Jose, Calif.-based Cisco Systems, which enjoys a dominant position in the enterprise market and also is focusing on Internet voice systems.
Since that employee e-mail landed in inboxes around the world, Dunn has reworked his quarterly "break-even" revenue estimate for next year, dropping it to below US$2.4 billion from below $2.6 billion. No matter, his confidence in the "long-term success" of the company is still "unwavering," he reported in a new e-mail to employees, and he is still pleased with the "significant progress on our way to restoring profitability." Again, he says he expects a profit by June.
"We don't believe that," says Wilson, the RBC analyst. "We're more pessimistic on the revenue side" - the side of the balance sheet Dunn has less control over. Expecting more spending cuts among carriers, Wilson doesn't see Nortel's revenues reaching bottom before the middle of next year and he doesn't see Nortel turning a profit until the fourth quarter of 2004, let alone making a meaningful amount of earnings before 2005. Still, Wilson says, it's a worthwhile strategy for Dunn to set an aggressive, near-term target for profitability. "Imagine working in that organization: two-thirds of the people have been let go; you haven't made money, in terms of operating profit, in two years; every day you pick up the paper and your industry is worthless." Setting a goal will galvanize staff, and suppliers and customers, Wilson says. "But for us on the Street, in terms of forecasting, caution is the better part of valour right now."
Caution is also the operative word for McWhirter, who manages the Northwest Specialty Innovations Fund, the No. 1 tech fund in Canada - even though there are signs of hope for Nortel. "We are now at least seeing hints that the telecom carriers - namely the actual phone companies - have bottomed out and are starting to move back up," McWhirter says. "We appear to be in a bottoming process for Nortel." Using a 12-factor computer model - nicknamed Einstein - to select stocks, he ranks 3,200 U.S. and 700 Canadian stocks based on best relative value. "Is my model saying buy it? No," McWhirter reports. In the past, telecom carrier stocks have led equipment companies, like Nortel, by roughly six to nine months, and they might again, but according to Einstein, it's too early to know.
John Roth, the man who drove Nortel up the bubble and back down - and who received C$135 million in a stock-options pay-out - has now completely severed his ties to the company. After leaving the CEO's post, he remained on the board for six months and then was granted a leave of absence, which ended last week. In August, when Nortel was trading at $1.55, he sold the last of his stock because, as he told TheStreet.com, "it was heartbreaking to watch this poor company go through a terrible spiral." That sense of pessimism is perhaps the only thing Roth shares with investor Ray Puhalski. Still, Puhalski says, there's "no point" in selling his Nortel holdings now. "They're worthless, except to leave to my grandkids."
What Dunn Must Deal With
Nortel Networks Corp. share price, after BCE Inc. spun off its holding in May, 2000.
May 3, 2000: $78.50
July 26, 2000: $124.50
Nov. 1, 2002: $1.94
Maclean's November 11, 2002