Column: Nortel not out of the woods

by Mathew on November 4, 2005

Here’s a column I just posted at globeandmail.com about Nortel’s quarterly results:

“At this point, it’s not hard for Nortel Networks to impress anyone with its financial performance. All the company has to do is report a fairly clean quarter with maybe a little bit of growth here and there, no massive writedowns and no slashing of growth forecasts, and everyone goes home happy. And that’s pretty much what the networking-equipment maker did in its latest quarterly report — in fact, it did even better than that. Revenue, for example, climbed by a substantial amount in what is traditionally a weak quarter, and Nortel also narrowed its loss. To add some icing to the cake, the company even boosted its growth outlook for the current year.

So that’s it then — Nortel’s back. Right? Not so fast.

While Nortel’s results look especially good when compared with the financial debacle of the past three years, the company can’t count on enjoying that kind of favourable comparison forever. At some point, it has to show that it is actually getting stronger and increasing its profits and market share, not just when compared to the lowered expectations of the past. On those terms, Nortel still has some distance to go before it is out of the woods. At least now it can see the clearing through the trees — all it has to do is actually get there.

One of the most positive events for Nortel has to be the arrival of former Motorola executive Mike Zafirovski as chief executive officer, despite the lawsuit filed by his former employer and the $11.5-million Nortel had to pay to settle it. If anything, all that does is reinforce how strategically important Motorola feels he is. But the biggest boost is simply getting someone who has experience in telecom equipment at the helm. Whatever other qualities he might possess, his track record compared with his predecessor has to be a plus when it comes to restoring some of the market’s faith.

In effect, this has helped to cancel out some of the negative impressions created by the bizarre Daischendt affair, in which Mr. Owens hired and praised former Cisco Systems senior executive Gary Daischendt, only to turn around a few months later and announce that both he and another former colleague from Cisco would be leaving Nortel, due to a difference of opinion on how to run the company.

Coming at a time when the networking-equipment maker was recovering from a toxic combination of forced financial restatements, securities investigations and shareholder lawsuits — not to mention continuing weakness in the telecom-equipment market — this was like a kick to the solar plexus for many people both inside and outside the company. It certainly didn’t endear the company to any of the customers whose business it was trying to win either. Although some critics say investors have been too quick to celebrate the arrival of Mr. Zafirovski, having a solid industry presence at the helm is bound to help Nortel rebuild its reputation a little.

While having Mike Zafirovski around is a positive for Nortel, however, there are still plenty of negatives to go around, even if you leave out things like the multiple shareholder lawsuits against the company and an ongoing investigation by the Securities and Exchange Commission.

One of the things that caused some concern in the company’s latest results, for example, was a drop in profit margins — a drop caused in part by a $71-million loss on a wireless equipment contract with a customer in India. In fact, as one analyst noted, the losses that Nortel has recorded to date on its Indian contract are almost equal to the amount of revenue it has booked on the deal. Although Nortel says it needs to take on such contracts in order to build its market share in countries like India, some wonder whether it’s worth it if the company has to effectively supply its products at a loss.

The company’s operating profit margin was also nothing to write home about — it came in at negative 0.5 per cent, meaning Nortel didn’t make money on its core operations after expenses. Wireless, which had been one of Nortel’s strongest segments, also had a disappointing quarter. The company’s sales of wireless products were weaker than most analysts expected, in part because sales of new CDMA products dropped by 19 per cent due to (among other things) a slowdown in network construction at Verizon and Sprint, two major customers. Some of that is likely due to consolidation, since Sprint recently acquired and is still digesting Nextel.

Several analysts say they are bullish on the future, and expect Nortel to boost its profit margins as telecom carriers in North America and Europe roll out new optical and wireless networks, but others say that Nortel has grown weaker during the past two years, and is no longer getting the key contracts it once did. “We have had major reservations about the competitive position of Nortel over the past year as our checks with industry contacts have continued to suggest a reluctance on the part of some to do business with Nortel,‿ said Moors and Cabot in a research note. “As a result, we continue to believe the company is losing market share.‿

Over to you, Mike.”

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