Number Crunching on NT

By Mark Evans | Published: April 4, 2008

All About Nortel is a one-man show. I write it, produce it, script it, sweep the floors, etc.

That said, there are some really smart people who read ANN, and whose knowledge of Nortel and the investment landscape leave me in the proverbial dust. One of these people is Frank Burch, who, from time to time, sends along valuable tips and insight. It got me thinking that maybe it was time for the first guest post on ANN so without further ado, here it is:

Nortel: Some Valuation Points

The recently announced split of MOT yields some interesting valuation discussions…even with MOT trading near a five-year low. Of note recently is a Bank Of America piece that says the non-handset business has gross margins of 35% and operating margins of 8.6%. BofA values the business at 1X 2008 sales.

In comparison, Nortel had gross margins in Q4 of 43.7%, and will average around 43% for 2008. This is almost 25% better than Motorola’s non-handset business gross margin of 35% and 66% better than Motorola’s total GM of 26.3%. NT expects operating margin of 6.5% for the year, but had operating margin of 7.4% in the fourth quarter.

Under this valuation scenario, NT is today worth $11.3 billion. Divide that by 498 million shares and that yields $22.70. Take out $2 for NT’s debt, if you like, and the stock is still worth over $20, even under the current turnaround numbers. If NT management can improve operating margins by a little more and get some more 40G, LTE and other wins, maybe we even get some revenue growth. Then, things get interesting.

Need more evidence that NT should trade at over $20 now? Simple. Companies in much worse shape are trading at vastly higher valuations. Nortel’s business metrics are getting better…and other company’s metrics are not! NT’s most recent quarter’s gross margins were more than 1000 basis points above MOT, ALU, TLAB, ARRS and 700 basis points above ERIC and ADCT. And yet, NT is trading at a deep discount to all of these names by several measures that are used in turnaround investing.

In addition, the change in operating margin for NT (measured in basis points) was better than almost all of its competitors…even CSCO. So, they are making progress.

Basis point change in operating margin for the most recent quarter for selected companies:

NT +338

MOT -330

ALU +296

TLAB -614

ARRS -540

ERIC -895

CSCO -79 (admittedly hard to improve)

ADCT +383

FFIV -765

Technorati Tags: Nortel

Now, I’m not comparing NT to CSCO right now and claiming it is worth $88 per share. CSCO has gross margins in excess of 62%. Its customers care nothing about price, because they love the products and it’s a safe purchase. Great. Another World. NT will get there.

Instead of saying that NT should be valued like CSCO, let’s compare NT to a couple of companies that, like NT, have had their share of troubles and are working to get back to normalcy. Let’s look at ADCT, TLAB and ERIC.

ADCT has much lower gross margins than NT, but a higher operating margin. NT is investing far more in the selling organization and R&D to increase sales in 2008 and beyond. ADCT is doing some good things and has made better progress than NT on cost cutting and sales growth. However, ADCT has benefitted in recent quarters from the Verizon FTTP program which is not sustainable over the long term.

TLAB is 1000 basis points below NT in gross margin and more than 700 basis points behind in operating margin as they are negative for operating profit. Like NT, they are barely growing sales. They are in far worse shape principally because of their dependence on legacy products

ERIC has seen huge reductions in its margins recently, both gross and operating…and sales growth is less than NT in the latest quarter. Margin issues stem from its exposure to low margin GSM business in emerging markets.

First, a comparison of some operational metrics:

And here are some valuation measures:

Extrapolating NT to a 1.11x sales multiple yields a price in excess of $20. I think NT is worth far more than that, but they have to show operating margin improvement to get there. In my next piece, I will talk Operating Earning and EPS and the potential for NT in the short, medium and long term. In the meantime, start buying.

Finally, don’t you hate how some Wall Street analysts downgrade a stock before the market opens…when they know it’s opening down 20 points…and then they tell their clients they downgraded it at the higher price?

In the spirit of the bull of The Street, let’s just say I recommended NT at $5.73.

This entry was posted in Financials, Stock. Bookmark the permalink. Post a comment or leave a trackback: Trackback URL.

sad sad day for nortel

Yeah, right!! This company has lost all credibility, their 1st line managers are driving this company into the ground. They need to get rid of the old farts the use to manage the legacy products, and get them out of the woodwork! I know for a fact that they (1st line managers with over 20 years with the company) are purposely making it hard for employees to have products that work at a 5 9's reliability by ignoring the principles of test and verification. There are so many other more reliable voip carrier products that Nortel will continue to lose market share. Not to mention that alot of the employees have been beat down and overworked, that they have lost faith in the company. The term carrier grade means nothing to Nortel's next gen VOIP products. If they are 5 9's reliable, I say prove it!!
Nortel watcher

Interesting analysis….but what still gets me is why NT mgmnt has not purchased shares besides those due to options and grants in the past couple months. Their absence sends a different msg about the stock's future.

I'm aware of Pearce's and Zafiro's recent purchases but they are at the BoD level unlike those of the executive leadership.
BeenThereDunnThat

Hey “Sad Sad Day…” Nice generalizations. As somebody on the inside, I am working with management that ARE doing everything possible to improve quality, balancing this with time to market requirements. Product development is occurring, with the only resistance I am observing is controlled growth – adding resources to projects require damn good justification…which I fully support.
Employees beat down and overworked? Possible in some organizations that were subject to empire building in the boom days. I personally feel that during the tech boom when Nortel was the fat and happy rising star, reality within Nortel was so perversely twisted, that the present state is a stark reality.
Reality sucks eh?
Another Nortel Watcher

Frank, the numerical analysis appears sound. The thing that it doesn't capture – which the share price clearly does – is confidence in Nortel.

The improvements in Nortel's margins have come mostly from cost-cutting efficiencies, something that the GEniuses are good at. For Nortel to prosper once again, customers and investors need to be convinced of a credible growth strategy, and the growth initiatives need to be put in context of the existing businesses that are approaching the point when erosion will begin to accelerate. VoIP took over from TDM voice and Nortel did fairly well at capturing a leadership position. I like what I read about 40G optical evolution. But what about CDMA? CDMA is a pretty big chunk of Nortel's business. Can Nortel continue to increase share in a declining market long enough to hold them over until they (might) make a business out of 4G, once the market settles on what 4G will be?

I'm a long way from being ready to buy because although the stock price is low, I think it can still go lower under the current leadership. I think Mike Z is impotent as CEO because he doesn't personally understand enough about Nortel's business at a time when there are so many things happening in the market and so many critical decisions to make. This is not necessarily an abnormal situation for a Fortune 500 company, but in Nortel's case it's a real problem because much of the cabinet shares the same weakness. How many successful turnarounds in technology-oriented businesses can you point to that were led by a team of outsiders – not just of the company, but also of the industry the company is a part of?

So here's the dilemma – by the numbers you present, Nortel should sell for around $20 per share, but clearly no investor is going to pay that until the confidence issue is resolved. But what about potential acquirers? Nortel would seem to be a good deal right now and the potential suitors have the option of making the necessary changes to restore the right value of the Nortel asset post-acquisition. Sounds like a plan. But the board can't/won't sell the company at today's firesale prices because of the same numbers you present. I imagine they might even get sued if they did.

So Nortel is kind of stuck in the mud at the moment (or should I say stuck in the snow, based on the winter in Ottawa this year?).
A Close Observer

There's a good body of evidence that demonstrates that a high percent of a stock's value is based on a company's long-term growth prospects. Most of the near-term expectations are already priced into a stock.

To echo Another Nortel Watcher, NT's price is depressed because the market does not yet have faith in Nortel's long-term growth prospects. When NT is able to demonstrate multiple quarters of growth, and credible prospects for continued growth, the share price will improve.
Frank Burch

Some valid comments for sure. Thanks to all so far for largely constructive thoughts.

From Beentheredunnthat, nice to hear that at least on employee at NT likes what is happening…ha ha. I’m sure there are many. I would think that for most employees, working at NT is very exciting right now. Hopefully, some of your co-workers will post thoughts about how things are working for them. They can probably do this without violating company policy etc. I have no idea about that.

This company was out of control and essentially unmanaged for many years. Zafirovski is committed to NT. There are plenty of jobs he has turned down by simply saying, “I’m busy.” Having met the man, he doesn’t seem like the kind of guy I would like to bet against. Zafirovski is running a company, not a hedge fund. Things take time in the real World. I would love to work for a guy like Mike Zafirovski.

Nortel Watcher: I couldn’t agree more. More of the senior executive team should buy stock. We have to be cognizant of the fact, however, that many of these people receive stock as a large part of their compensation package. They have to be prudent in diversification of their assets. Also, some of the insider data seems very late, confused or in error. For example, a few days ago I saw on my Bloomberg Terminal a bunch of Form 4’s which indicated all sorts of insider buying. Then, 10 minutes later, they disappeared from the news stream that they were on. Very weird. At the end of the day, I wholeheartedly agree with you. Senior executives need to buy stock with cash and publicize the fact.

Another Nortel Watcher: Confidence is important..both from customers and investors. Regarding CDMA. It’s something to discuss, certainly. My take is that CDMA revenue grew 5% at Nortel last year and will continue to grow for awhile. The fact is, technology changes occur slowly and there will be plenty of spending in this area. Naysayers can’t have it both ways. You can’t say CDMA spending will grind to nothing and that emerging technology spending will be non-existent. NT is in a good place as it is covered in either case. I would also point to some interesting comments from a well respected analyst, Chris Umiastowski of TD Newcrest, on this point. In a recent conversation with Richard Lowe at CTIA, Lowe indicated that the next few years look good for CDMA and that the transition to new tech is orderly.

On your next point regarding NT management and having a non techie run the company. First, Z was the COO of MOT for several years…and it was a great time for MOT and I believe Zafirovski was a key player in the success and left in 2005. Second, the management team has plenty of technology experience in the senior ranks beyond Z. Binning, Lowe, Morin, Edholm, Wendt, Roese, Riedel and the list goes on. Some will say Hackney is not a techie because he doesn’t stay up late designing OAM tools. He ran a European medical technology business for GE that (if it were independent) would probably have a market cap larger than NT. Hackney will chew his arm off to be successful in Enterprise.

Some jobs are filled by execution guys. Do you need a tech guy to lead the supply chain?

Next (if I were to concede your point): Ever hear of Lou Gerstner and IBM? Gerstner came from RJR Nabisco and American Express and McKinsey. Mark Hurd was CEO of NCR…a maker of ATM machines, point of sale terminals and kiosks…hardly a HPQ.

Finally, there have always been top technology people at NT. What has been lacking is a good senior management team, until now. When Z joined NT there were 80,000 SKUs and over 1 million components in their products. You don’t need a technical PhD to fix that problem…you need a manager.

I agree with Another Nortel Watcher on the point of the stock being in la la land. The stock has to go up to either buy companies or be bought. NT will have to keep executing. They have to grow sales and operating margin. I think they will do this. They have some exciting new products coming on line. More on that later. If the credit markets were in better shape, a private equity firm would snap up NT ala Avaya. That would not be good at even 3x the current price. There is just too much potential at NT.

Thanks for the comments. Sad Sad Day for Nortel…I just can’t add value to your comments, but they are appreciated.
Apple

You don't have to wait long to see how NT is doing. Q1 2008 is coming soon, isn't it?
Lets wait and see all the margins and profits.
While NT is still spinning the wheels and not getting traction new companies are coming to the market and are bigger than NT now.
Huawei, as Mark E posted here yesterday, is bigger than NT as we speak.
Next year another Chinese giant comes to the $10 bill level in revenue, ZTE
Why customers buy from HW+ZTE when they would buy from NT ALU or ERICs?
All the growth is shifted into HW and ZTE, isn't it?
2008 they will sell for $25 bill
2009 HW+ZTE will sell for $37 mill
2010 HW+ZTE total will be much bigger than CSCO revenue!
How do you like it, NT's bulls_optimists?
I say it's time for NT to give shareholders the best value right now by finding an acquirer!
OH no, it's NT, Canadian company which doesn't care about shareholders!
They love AirCanada scenario!
First use BK protection, restructure the company and sell it to new shareholders!
Mike did not sell NT at $35 when he came to take CEO job. Would shareholders be in better position than now?
What shareholders have from that BTPlan?
What employees get? Mike fired 9000 of them /or is in process of doing so/
Mike will get his millions no matter what!
disclosure, I've been bearish on NT in last 5 years.
http://www.microsoft.com Name Corporate Citizen

Time will tell if Nortel will rise again, or wither away like a flower in the sun. My bet is that it's going to be a very dry summer for Nortel's 5 9's carrier products.
Another Nortel Watcher

Frank – Excellent response. Thank you for taking the time to respond. Now as to your points…

MZ is an energetic figure, but I don't share your enthusiasm for his leadership. I don't give him credit for the good years at MOT when he was there. My understanding is that he successfully streamlined operations (as he has done at Nortel) and basically just didn't get in the way of the RAZR team. I don't think these accomplishments say a lot about his potential to drive growth at Nortel.

We agree that Nortel may be able to grab CDMA business in the near term, but surely you agree that that is a dead-end business. It's a question of when, not if. I'm sure Richard Lowe is working on plans to transition the business to 4G, but let me ask you this – how big do you think Nortel's share of the 4G market will be? Nortel is one of the dominant tier-1 vendors in the CDMA market. 4G introduces a lot of additional players as the GSM, 3G, and CDMA worlds converge and it looks to me like there is serious risk that Nortel will end up as a tier-2 player in the 4G market. Nortel simply cannot invest enough now to keep up with the crowd.

Nortel has some great leaders, but I disagree with some of your opinions. Sure, Richard Lowe has been there for a long time but I really don't see any evidence that he 'leads' what's going on around him or is acting as an industry leader. His posted interviews and public appearances are far from inspiring. As for Joel Hackney, I don't think he'll 'chew his arm off' to be successful, I think he'll 'pull someone's face off' (I know, I know…that's a dig…but it's fair and he brought it on himself). When a market is in transition, it takes more than sheer drive to be successful – it takes personal insight. My longtime beef is that none of MZ, Lowe, or Hackney bring that to the table.

Finally, I recognize your point about Gerstner and Hurd. They are not experts in their company's segments but you must acknowledge that their market segments are in less turmoil than the telecom business. The focus in the computer industry is sheer efficiency…more processing power, more memory, less footprint, less cost, effective services. I get it. MZ would be great in the PC world. The telecom challenge is much less defined and that's the problem. There is no recipe or industry roadmap at this point. Too many things are changing all at once. And for that reason, I think MZ will continue to struggle.
Apple

In the spirit of the bull of The Street, let’s just say I recommended NT at $5.73.
=============
re
In the topic of giving investing advice tell us when it is good to sell NT?
I know one thing
that NT makes new lowest levels each and every year since I started watching that stock in 2004
If we are talking about the stock, why don't you consider all important things for the stock coming soon
1 14.5% stock dilution pending
2 debt repayment obligations in 2008 and total debt
3 pension plan deficit /in 2008, NT will use around $350 mill cash for that as I remember/
4 SEC vs Nortel's managers trials coming which will show how who when why….
Nortel defrauded investors and the public in general
5 Criminal investigations are going to end one day and criminal charges will be laid most likely /links available/
6. M&A is one of the biggest Mike's failures!
7. Tax credits still on the books as the biggest asset
8 competition growing fast.
examples,
Huawei which was small few years ago is bigger than NT right now and will grow to the size of $25 bill in 2009 /$30 bill in 2010 ?/
ZTE is going to be $10 bill company soon as well.

new article about that here
http://www.lightreading.com/document.asp?doc_id…
don't forget to read page 2 too and the comments under that

HW 70 k employees 35 k in R&D
NT 30k employees 12k in R&D
btw
and I still know that Canada likes AirCanada scenario to deal with shareholders/ Mike Z likes that story too-links available/
Can NT be profitable soon? that's the question!
Maybe Frank can tell us about that?
Why NT gets 2.5 mill new lines for $40 each from BSNL in 2008 “new deal”?
Why the mystery here?
Shouldn't public be inform about that?
Why ERIC posted all the info about $100/line deal with bsnl?
Is NT still a public company?
Is speculating about NT stock permitted?
Lets see both sides of NT stock and let investors decide if investing in NT is better than playing roulette in Las Vegas!
Nortel Will Survive

Those predicting a short term death to CDMA clearly do not understand the market. Have a look at CDMA Market Size information found on the CDMA Development Group website:

254 commercial operators
99 countries
250 commercial 1X networks
27 1X networks in deployment
84 commercial 1xEV-DO Rel. 0 networks
50 1xEV-DO Rel. 0 networks in deployment
27 commercial 1xEV-DO Rev. A network
31 1xEV-DO Rev. A networks in deployment
417,500,000 CDMA2000 subscribers (4Q 2007)
90,534,000 CDMA2000 1xEV-DO subscribers (4Q 2007)

Do you really think that over 400 Million users are going to be forced to purchase new devices over the next couple of years, just because of a new technology such as LTE? That would be a foolish prediction based on how consumers really work.

I fully expect CDMA to be around for another 5 to 10 years with continued growth in the 250 networks. I expect many of these networks to evolve to LTE while supporting both LTE and CDMA in a dual-mode arrangement.

Also, since WiMAX and LTE use a set of common technologies already developed by Nortel, it's not like Nortel has to re-invent everything. The big challenge for all players will be the dual-mode development of voice on CDMA and data on LTE with LTE running in the 700 Mhz spectrum. Nortel has commited to this and is working directly with Verizon to make this happen for late 2009.

If CDMA is going to die, then so will GSM in time. Get real people.
Cole McKeon

The reason that Nortel's valuation is so low is that nobody in telecom thinks they have a real future – a clear strategy is missing, they have sold their soul to MS on the enterprise side, and they sold their next gen wireless technology (UMTS) to Alcatel last year- what's left – a disenchanted customer base looking for an exit?
NT2North

Very clear you know nothing about telecom.
Another Nortel Watcher

NWS – you're confusing Nortel's business with the Operators business. CDMA will be around for some time, but the relevant question is how long will operators be building out CDMA networks before they shift the majority of spend to 3G or 4G? And how much of that business will Nortel secure?
Nortel Will Survive

ANW …. from your post you asked – but the relevant question is how long will operators be building out CDMA networks before they shift the majority of spend to 3G or 4G? And how much of that business will Nortel secure?

So, how long will operators be building out GSM and UMTS networks before they shift the majority of spend to LTE?

If the move is to 4G, then CDMA, GSM and UMTS will all be impacted. I guess that means that Ericsson, Nokia and others will also be impacted, potentially even more than Nortel.

Who knows how much business Nortel will secure, just like we don't know yet how much business Nortel competitors will secure. Your FUD is pretty lame since Nortel has increased their CDM market share and is #2 in the CDMA market.

Why would a GSM operator purchase UMTS when a direct upgrade to LTE will be available in 2009? Using your FUD technique, I guess Ericsson could be in a world of hurt since they are pushing HSPA these days.
Another Nortel Watcher

NWS – I don't think GSM operators are going to be spending much to build out their GSM infrastructure any more than CDMA operators are. As soon as there is a viable next gen alternative, they will shift to it.

LTE looks to be the 4G standard that the world is converging on, but it's going to be a few years before we get there. In the meantime, for most of the world UMTS is a viable transition step.

As for market share predictions, I think a dominant share of GSM/UMTS bodes well for a good share of LTE. I don't think a dominant share of CDMA has nearly as much leverage.
many

ANW & NWS; I can tell you that UMTS is already there in the NFL cities and along the interstate transport corridors and that HSDPA is a matter of upgrades, not installations. The full impact of the current recession is not fully understood yet (it might be very good for telecom, it might be bad), so no one is in any great hurry. I suspect that trial deployments will be held until the fog clears.

The likely strategy is “cap and grow” Cap the GSM technology (GSM/CDMA) and grow the new UMTS/HSDPA where it makes financial sense; as it is justified by current traffic, but not on speculation that the market is there. Most likely in the primary MSA's/NFL cities. TDMA has been turned off and footprint/power/cooling capacity is being reclaimed (there is big money in decommissioning).

Of course targeted upgrades to LTE will be rolled out when it is tested and available, but LTE is not even close to product ready yet, standards are still in flux, the market for the speed it provides is not there yet, the vendors equipment (mostly base stations) do not support Ethernet (still mostly TDM) , I don't even think LTE is in the service provider Labs yet.

All of this could be greatly accelerated with a major telecom infrastructure incentive from the governments, but it does not look like that will happen this year at least in NA

BTW what is ANN? Shouldn't it be AAN?
puddintane

Generally speaking, a book documenting the absolutely staggering waste perpetrated in the heyday of RLO spending prior to 2000 could be pretty entertaining.

Folks gleefully dumping their entire desk drawers into the trash because their boring pencils didn't match their lame erasers, then wasting entire weeks on end color-coordinating newer, more “appropriate” stationery and consumables, then sitting back and playing Blackjack until new stuff got delivered…
Backplane cards on then brand-new Passports impatiently smashed into place, thus bending and breaking guide pins over and over, then shipping the whole shebang quite blithely and repeatedly back for costly repairs in the $2000+s while the elite kicked back and ogled dog porn, whilst also doing everything else conceivable on company time…
“OT” surpassing “95 hours” never questioned or verifed… several UMTS labs built back in the late '90s just sitting around blinking for 10 or more years…

Seasoned perfasionals quitting stupid ole boring Nortel to join any number of high-falutin' startups that lasted all of 6 months, but allowed ordinary installers to buy fully decked-out mammoth 4x4s with all the extras….
Nortel watcher

puddintane,
you're a bit off the beaten path below, but heck all is fair when you are talking about Nortel's profitability…there's one thing I can add to your comments about the freespending days of Nortel and that's the outrageously generous expat packages they gave employees – $200K annual salaries and the company picks up the entire housing cost, etc. etc.
Seeker

Yeah, but what about Nortel deficit in their pension plan. Amounts to 2 billions ? May be more ? How will they found that back ?
Seeker

Oupss ! Should have wrote 'fund'
Apple

Let's revisit Frank Burch and his Strong Buy advice posted here before Q1 2008
We know that Q1 was not profitable, once again, and the stock has been falling down in 2008 because Frank neglected 14.5% dilution
Ottawa Citizen article explained lately why NT stock lost 44% value in first 4 months_6% new shares distributed so far
Oh look Frank, I listed 14.5 % dilution in my bearish on NT post as nr 1 on my list for investors to consider….
Does it tell you anything?
Do you know that second step is to distribute another 8% to small investors before July and Ottawa Citizen is bearish on that as well…
What about other points I listed above?
look at point nr 3 I listed
Q1 2008 report says that NT had to use cash to pay part of the total $350 mill PensionPlan deficit obligations for 2008 and it was one of the reason NT reported their loss.
Instead of admitting being wrong, Frank stated that all analysts and stock market is wrong about NT.
Very funny and entertaining as watching Don Quixote. Thax Frank
frank burch

The share distribution has been well telegraphed. Even the analysts have had these shares in their numbers for several quarters. Everyone has been using a number of 500 million shares for a long time. Any short term downtrend due to selling of this distribution is free money for a buyer who can hold for 1 1/2 months.
Apple

re Frank

Six big losers on NT
1. Brandes $155 mill loss
2. Capital World Inv $149 mill
3. Wellington $98 mill
4. Growth Fund $ 87 mill
5. Dodge and Cox $ 79 mill
6. Frm Corp $31 mill
You can find it here
http://www.mffais.com/nt.html

Ottawa Citizen published that
http://www.canada.com/ottawacitizen/news/bustec…

Showing that selling “new shares” 6% of total dilution
Was the cause for NT to collapse in first 4 months in 2008

Read
Bert Hill, The Ottawa Citizen
Published: Wednesday, May 07, 2008
Nortel Networks' depressed share prices could face even more pressure in the coming weeks.
The reason is that 33 million company shares will be distributed by the end of June to investors who lost money in the 1999-2003 accounting scandals. The shares represent about eight per cent of the company stock and follow a distribution of 28 million shares in the first four months of 2008 that helped drive down prices by 44 per cent.
=========
As you see,. 14.5% stock dilution wasn’t in NT stock price… when you settle in 2006 and distribute the shares in 2008, market does not remember that it was already in.
Who would you blame for such delay?
frank burch

I'd blame the lawyers. NT delivered the stock over a year ago. The lawyers and the courts held up distribution doing what they do best, looking out for themselves. They cost people that would have wanted to sell.
frank burch

I'd blame the lawyers. NT delivered the stock over a year ago. The lawyers and the courts held up distribution doing what they do best, looking out for themselves. They cost people that would have wanted to sell.

	Facebook
	Twitter: markevans
	LinkedIn: Mark Evans
	FriendFeed
	Flickr

Number Crunching on NT

Mark’s Blogs

Find ME Online

Categories

Blogroll