Earlier this week, I mentioned an interesting and insightful research report by Dundee Securities’ Tom Astle, who covered Nortel from 1992 to 2007. Tom was good enough to give me the green light to publish the complete report, which is titled: “Nortel – Zero to Hero to Zero”.
Note: The last two-thirds of the report can found if you click on the “Read More” link. Eight Lessons learned from 15 years of coverage
I first started following Nortel as a sell-side analyst in 1992. I officially threw in the towel in 2007 (fortunately!). You could say I almost made a career out of following the name. But my connection with Nortel like many of us in my generation and occupation began much earlier when I graduated from engineering school in the early 80s. Then and for about 20 years Nortel would probably hire more engineers in this country than any other single company. I was fortunate enough to be offered a few jobs by Nortel and its research arm BNR (Bell Northern Research) – but I never accepted them and decided to help build aircraft simulators at CAE instead. But many of my colleagues rushed off to work in the sacred NT labs in Ottawa or elsewhere. Some are still there and I wish them luck.
While it feels like I’m writing an obituary, the real purpose of this note is to reflect on what I might have learned from following Canada’s largest innovator from its days in relative obscurity (for investors) in the early 90s to a massive Wall Street darling in 2000 and now after 8 years of struggles to a Shakespearian like ending – at least for equity holders.
I’m guilty. In my 15 years of coverage I probably more often than not had a positive rating on the name. While I often expressed caution, I can’t recall ever having an outright SELL on the name. And that’s probably a lesson in itself – I wish I had been more assertive in our cautious views. But the following eight lessons (from among many) are the ones that I am reflecting on as I painfully remove the NT symbol from my screen. Sniffle, sniffle.
Capital structure is key
Nortel always had the wrong capital structure for a growth tech company. Is Cisco, Nokia, RIM, Ericsson or Motorola in the same pickle as NT? Their balance sheets are much stronger. Some of them have better balance sheets because they know how to generate cash (which is the real lesson here) but many of them also raised equity money when they could – not when they needed it. I believe many of Wall Street’s largest firms told NT in 1999-2001 that it could easily raise upwards of $5 billion in equity. It also had the opportunity to spin out a small fraction of its optical component division for a similar amount of cash. This would have cleaned up all of its debt and we’d be watching a different movie now.
Imagine if RIM hadn’t raised large amounts of equity in its formative years and had walked into the 2001 slowdown and NTP settlement with a weak balance sheet. Good companies raise equity when they can – not when they need it.
Calling a turn-around is hard
Maybe it’s just me, but I found calling NT’s stock very difficult after 2002. My skills and most tech investors’ skills are honed on predicting growth attributes. Things like product cycles, key technologies, competitive positioning – not the impact of restructuring plans, asset sales, balance sheet repair, etc. Growth investors should probably flee a growth name when it falls on hard times and let the deep value guys take over.
I was on a March Break holiday in 2004 when Nortel asked its CFO to take a holiday – effectively ending my holiday. My first reaction was – hey it’s still a good company with good products and good customers and a few accounting errors can be quickly repaired. But it soon became apparent that this was more than a few misplaced decimals on the ledger. When boards suspend CFOs (and CEOs) something must really smell. And that smelly stuff tooks years (and many restatements) to fix. From this point on the only people making good coin were the accountants and lawyers – come to think of it, they are still doing well by Nortel! In a fast and competitive industry, one good accounting scandal can be fatal.
Play the early part of the product cycle
And leave well before midnight. NT was a diversified player, but on a few occasions it was also a leader in a key single product cycle. And investors that recognized this probably traded the stock well. For example, it was a clear leader in the optical internet buildout. For a couple of years in the late 90s it was the only company on the planet that could build fiber optic networks that kept up with growing Internet traffic. The first few years of this product cycle were real and a great time to own the stock. But all product cycles mature out and often have a bad ending as markets get overbuilt. Find a product cycle, get in early with the leaders and most importantly (and the hardest), get out early.
Look at implied growth
Back near the height of the tech bubble I decided to look at what kind of growth the valuations of the big tech names, including NT, were baking in. My analysis suggested that NT, then a $30 billion/yr company, needed to maintain 30-40% growth for the next 5 years. How many $30 billion/yr companies do you know that have grown at that rate? Well NT did manage about 30-40% for the next few years – unfortunately those were decline rates not growth rates! I wished I had paid more attention to my own analysis.
Good management is hard to judge and they can’t fix everything
Paul Stern, John Roth, Mike Z – they all looked great to us at the beginning. Maybe they were great managers, maybe they weren’t. But my guess is that most analysts think they are better judges of management quality than they are. After all, if we analysts were so good at management, wouldn’t we have a “real” job running something – instead of just “commenting” on people who run things.
The other issue here is that management teams are not in the miracle business. External factors can and often overpower management’s ability to fix (or screw-up) things. The lesson here is to focus on external factors and actual company results and concrete actions – and don’t get lost in the rhetoric of polished management teams.
Focus on balance of power
The one thing Nortel suffered from during the last eight years was an imbalance of power with its major customers, the carriers. Only during the tech/telecom bubble did NT have an attractive balance of power due to its competitive advantages in optical networks and the rapid growth of alternative carriers.
During the last few years its carrier customers massively consolidated giving them more purchasing power. Meanwhile Nortel’s competition actually increased through Cisco’s arrival in the sector and new Chinese players. Its relative power in the sector was further weakened through mergers of many of its competitors (think Alcatel/Lucent, Nokia/Siemens, Ericsson/Marconi) who were trying to match the carriers purchasing power with supplier concentration. In hind sight, I’m guessing Nortel management is wishing they danced a little longer with a few of its competitors a few years back.
Equity Shareholders don’t come first
Finally I think it’s appropriate – especially at this juncture to remind investors that when companies get into the kind of pickle NT is in, management is likely not spending one moment worrying about its equity holders. It has to focus on those that control its destiny – specifically the debt holders and some employee obligations.
My guess is that the likely outcome is that Nortel is NOT broken into pieces and sold off in a fire sale, as this is terrible market for asset sales. But rather that NT works out a deal with the major debt holders to give them pennies on the dollars (both in new secured debt and a little cash) and BIG whack of new equity – effectively diluting existing equity holders down to next to nil.
Very refreshing analysis. I'm in a blue mood with this whole Nortel demise. I built a business partially around Nortel. This movie is sooooo hard to watch...At the same time I have a business to run, and so I'm trying to really understand whether there is any sense in investing precious company funds in further Nortel training or just begin the switch to Cisco and/or another vendor like Mitel.
The official word from Nortel to its Enterprise reseller partner community seems like so much PR, so independent (tell it like it is) anlysis is really important to folks like me now. Thanks to All about Nortel, Tom and Mark for your perspective.
BDB
protosphere
What an informative and brilliant author this Tom Astle with the rare ability to count and spell. I add him to my proven heros list with Mark and Duncan.
I only questions, swimming against contemporary tide yet again, whether there will be anything left to restructure with considering their catalyzing decline after my much anticipated Chapter 7.
NortelEmp
Lesson 6: "The lesson here is to focus on external factors and actual company results and concrete actions – and don’t get lost in the rhetoric of polished management teams."
Last summer's analyst conference and the one from the previous year were perfect examples of how analysts can get caught up in management hype. Although the facts (internal and external) indicated otherwise, analysts bought into promises and creative communication. To what extent, therefore, did analysts contribute towards the current situation? Had the analysts stuck to the facts and 'punished' management until the facts were cleaned up, maybe management would have behaved differently.
Is it only insiders who are responsible for a company's demise or are there controllable external influences that also contribute? (That's a rhetorical question).
Tom Astle’s Take on NT: From Zero to Hero to Zero
Earlier this week, I mentioned an interesting and insightful research report by Dundee Securities’ Tom Astle, who covered Nortel from 1992 to 2007. Tom was good enough to give me the green light to publish the complete report, which is titled: “Nortel – Zero to Hero to Zero”.
Note: The last two-thirds of the report can found if you click on the “Read More” link.
Eight Lessons learned from 15 years of coverage
I first started following Nortel as a sell-side analyst in 1992. I officially threw in the towel in 2007 (fortunately!). You could say I almost made a career out of following the name. But my connection with Nortel like many of us in my generation and occupation began much earlier when I graduated from engineering school in the early 80s. Then and for about 20 years Nortel would probably hire more engineers in this country than any other single company. I was fortunate enough to be offered a few jobs by Nortel and its research arm BNR (Bell Northern Research) – but I never accepted them and decided to help build aircraft simulators at CAE instead. But many of my colleagues rushed off to work in the sacred NT labs in Ottawa or elsewhere. Some are still there and I wish them luck.
While it feels like I’m writing an obituary, the real purpose of this note is to reflect on what I might have learned from following Canada’s largest innovator from its days in relative obscurity (for investors) in the early 90s to a massive Wall Street darling in 2000 and now after 8 years of struggles to a Shakespearian like ending – at least for equity holders.
I’m guilty. In my 15 years of coverage I probably more often than not had a positive rating on the name. While I often expressed caution, I can’t recall ever having an outright SELL on the name. And that’s probably a lesson in itself – I wish I had been more assertive in our cautious views. But the following eight lessons (from among many) are the ones that I am reflecting on as I painfully remove the NT symbol from my screen. Sniffle, sniffle.
Capital structure is key
Nortel always had the wrong capital structure for a growth tech company. Is Cisco, Nokia, RIM, Ericsson or Motorola in the same pickle as NT? Their balance sheets are much stronger. Some of them have better balance sheets because they know how to generate cash (which is the real lesson here) but many of them also raised equity money when they could – not when they needed it. I believe many of Wall Street’s largest firms told NT in 1999-2001 that it could easily raise upwards of $5 billion in equity. It also had the opportunity to spin out a small fraction of its optical component division for a similar amount of cash. This would have cleaned up all of its debt and we’d be watching a different movie now.
Imagine if RIM hadn’t raised large amounts of equity in its formative years and had walked into the 2001 slowdown and NTP settlement with a weak balance sheet. Good companies raise equity when they can – not when they need it.
Calling a turn-around is hard
Maybe it’s just me, but I found calling NT’s stock very difficult after 2002. My skills and most tech investors’ skills are honed on predicting growth attributes. Things like product cycles, key technologies, competitive positioning – not the impact of restructuring plans, asset sales, balance sheet repair, etc. Growth investors should probably flee a growth name when it falls on hard times and let the deep value guys take over.
Technorati Tags: Nortel
When the CFO leaves in a hurry, so should you
I was on a March Break holiday in 2004 when Nortel asked its CFO to take a holiday – effectively ending my holiday. My first reaction was – hey it’s still a good company with good products and good customers and a few accounting errors can be quickly repaired. But it soon became apparent that this was more than a few misplaced decimals on the ledger. When boards suspend CFOs (and CEOs) something must really smell. And that smelly stuff tooks years (and many restatements) to fix. From this point on the only people making good coin were the accountants and lawyers – come to think of it, they are still doing well by Nortel! In a fast and competitive industry, one good accounting scandal can be fatal.
Play the early part of the product cycle
And leave well before midnight. NT was a diversified player, but on a few occasions it was also a leader in a key single product cycle. And investors that recognized this probably traded the stock well. For example, it was a clear leader in the optical internet buildout. For a couple of years in the late 90s it was the only company on the planet that could build fiber optic networks that kept up with growing Internet traffic. The first few years of this product cycle were real and a great time to own the stock. But all product cycles mature out and often have a bad ending as markets get overbuilt. Find a product cycle, get in early with the leaders and most importantly (and the hardest), get out early.
Look at implied growth
Back near the height of the tech bubble I decided to look at what kind of growth the valuations of the big tech names, including NT, were baking in. My analysis suggested that NT, then a $30 billion/yr company, needed to maintain 30-40% growth for the next 5 years. How many $30 billion/yr companies do you know that have grown at that rate? Well NT did manage about 30-40% for the next few years – unfortunately those were decline rates not growth rates! I wished I had paid more attention to my own analysis.
Good management is hard to judge and they can’t fix everything
Paul Stern, John Roth, Mike Z – they all looked great to us at the beginning. Maybe they were great managers, maybe they weren’t. But my guess is that most analysts think they are better judges of management quality than they are. After all, if we analysts were so good at management, wouldn’t we have a “real” job running something – instead of just “commenting” on people who run things.
The other issue here is that management teams are not in the miracle business. External factors can and often overpower management’s ability to fix (or screw-up) things. The lesson here is to focus on external factors and actual company results and concrete actions – and don’t get lost in the rhetoric of polished management teams.
Focus on balance of power
The one thing Nortel suffered from during the last eight years was an imbalance of power with its major customers, the carriers. Only during the tech/telecom bubble did NT have an attractive balance of power due to its competitive advantages in optical networks and the rapid growth of alternative carriers.
During the last few years its carrier customers massively consolidated giving them more purchasing power. Meanwhile Nortel’s competition actually increased through Cisco’s arrival in the sector and new Chinese players. Its relative power in the sector was further weakened through mergers of many of its competitors (think Alcatel/Lucent, Nokia/Siemens, Ericsson/Marconi) who were trying to match the carriers purchasing power with supplier concentration. In hind sight, I’m guessing Nortel management is wishing they danced a little longer with a few of its competitors a few years back.
Equity Shareholders don’t come first
Finally I think it’s appropriate – especially at this juncture to remind investors that when companies get into the kind of pickle NT is in, management is likely not spending one moment worrying about its equity holders. It has to focus on those that control its destiny – specifically the debt holders and some employee obligations.
My guess is that the likely outcome is that Nortel is NOT broken into pieces and sold off in a fire sale, as this is terrible market for asset sales. But rather that NT works out a deal with the major debt holders to give them pennies on the dollars (both in new secured debt and a little cash) and BIG whack of new equity – effectively diluting existing equity holders down to next to nil.
Have a good day, eh.