According to Genuity Capital Markets analyst Deepak Chopra, RIM could be interested in Nortel’s IP:

“The bid for Nortel’s CDMA and LTE access business is puzzling, as this is outside of RIM’s core area of expertise and the networking business is hyper competitive with a lower margin structure,” he said in a research note. “Most companies in the networking space are not making any money. The primary reason for the bid, we believe, is Nortel’s intellectual property, as it has key patents in LTE and CDMA. In a press announcement a year ago, Nortel indicated that it was willing to sign licences for its patents that are equivalent to 1% of LTE revenues. If Nortel’s IP can generate that level of royalty from LTE, the patents could produce hundreds of millions in revenue per year. For example, if 100 million LTE handsets are sold by 2013 with an average ASP of $150, the potential royalty revenues would be $150 million.”

Chopra also suggests that with a stronger IP portfolio, RIM would have more negotiating power with other wireless suppliers:

“As we have mentioned before, RIM is buying patents to build its portfolio and strengthen its negotiating position with other wireless vendors to reduce its effective royalty rate. Essentially, RIM is using its balance sheet to substitute its relatively short history to build its patent portfolio. RIM has spent $1.3 billion on patents over the past two years (also includes Certicom acquisition), and another $270 million to settle with Visto. If the IP is the primary target, we could see RIM sell the network business. As of December 31, 2007, Nortel had approximately 3,650 U.S. patents and approximately 1,650 patents in other countries. It has been reported by industry analyst IFI Plenum that, in 2006, Nortel ranked 69th in terms of number of patents granted by the U.S. Patent & Trademark Office.”

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.

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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.

In a research report, “Nortel: January bankruptcy filing?”, Theodosopoulos said declaring bankruptcy in January “may make sense to maximize franchise value”, and allow the company to avoid an interest payment of $100-million to $120-million due on Jan. 15.

“We believe a likely challenging 4Q08, weakening 09 outlook and tightening DIP financing may cause Nortel to withhold its interest payment and possibly pursue an early bankruptcy,” he says.

Source: NetworkWorld

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The decision to downgrade NT to a “reduce”, he said, is based on the expectation that Nortel will have sales materially below consensus, and force Nortel into asset sales sooner rather than later.

The suspension of the target price is based on the belief Nortel’s shares are “trading more like a call option on the successful outcome of a business transformation along with some asset sales. This situation is incredibly hard to value, and the stock price is naturally going to be highly volatile”.

Umiastowski said he believes more restructuring is necessary, and that $900-million in cuts are needed to give Nortel a “realistic shot” at having 10% operating margins.

“Unfortunately, this will require cash, and would put the company closer to being in a cash crunch. It seems the only way out is to sell assets, which Nortel is currently trying to do (e.g. MEN business is for sale),” he wrote in a research report. “We believe that Nortel must either succeed in selling assets at reasonable prices, or face increasing risk of inevitable bankruptcy.”

Umiastowski does not believe Nortel will file for bankruptcy protectionin 2009 but he’s concerned the company may not be able to sell its metro Ethernet business or other assets given the current market conditions.

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With a $1-billion bond not coming due until July 20011, Thompson expects Nortel will end 2009 with $1.4-billion in cash.

“With no short-term debt obligations and the possibility that Nortel can successfully restructure, we would not expect CCAA as a near-term consideration by the company,” he said in a research note.

If anyone has access to Thompson’s report, it would be great if you wanted to pass it along.

More: S&P analyst Ari Bensinger said while Nortel has no major debt obligations until 2011, the “forecast for $1 billion in negative cash flow and $1.5 billion in working capital requirements for 2009, NT has little buffer room to fund operations”.

Sources: National Post, BusinessWeek

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“While recognizing that shares are down 96% YTD and that additional downside is likely limited on an absolute basis, we believe shares will under perform the group and the broader market over the next twelve months. We see no real catalyst for shares, and with a declining demand environment, we believe there is little chance that shares will stage a meaningful recovery.”

With such a bleak outlook, you have to wonder why Cowen & Co. bothered.

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Its decision was based on the lack of “any near-term growth catalyst”, as well as “the company’s debt level, disappointing financial expectations, and general economic weakness that may impede near-term improvements”.

“Nortel…is facing severe business challenges as a result of the global economic slowdown, increasing competition, and reduced capital spending on the part of several of its major customers” Zacks said in a research note, adding that the company’s third-quarter results were “significantly below expectations”.

“Revenue from all four business segments decreased year-over-year with further declines expected over upcoming reporting periods. In addition, increasing cash burn rate and a highly leveraged balance sheet remain concerning.”

Chart source: TradingMarkets.com

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In retrospect, it strikes me as an irresponsible decision because it suggests that Nortel as an operating entity is doomed with no value. As much as Nortel is troubled and has its financial and strategic challenges, Sue is making a huge assumption that can only be described as extreme.

The question is what does Sue see that others don’t. Even a bearish analyst such as National Bank’s Kris Thompson has a 50 cent target price, while the average target price – according to Thomson/First Call – is $1.10.

Maybe Sue is frustrated after having being forced to continually lower his target price, or perhaps he believes Nortel’s prospects are, indeed, bleak. You do have wonder, however, why he stands alone in his ultra-bearish approach, and why zero seemed like such a reasonable number.

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On why he has a $5 target price, and RBC Capital Markets’ Mark Sue now has a target price of zero:

“I’m of the view that either he’s right or I’m right and that everyone else in-between can’t possibly be right.”

On why he thinks Nortel is worth at least $5/share:

“The business should be worth a lot more than $5 a share, unless they run out of cash.”

Richards told CP that Nortel’s wireless equipment business is worth US$2 billion, the optical equipment business US$3 billion, and the enterprise division at US$5 billion — once they each absorb parts of Nortel’s services business, which runs networks for customers.

More: Larry MacDonald, who owns Nortel shares, remains optimistic that Nortel has upside.

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Yesterday, RBC Capital Markets’ analyst Mark Sue dropped his target price to zero, and now National Bank’s Kris Thompson has issued a research note suggesting that Nortel shareholders could be doomed because bondholders will have priority in the event Nortel files for bankruptcy protection, add that Nortel’s bonds are trading at 21% to 41% of their face value.

“If the bond holders are right, the outlook doesn’t look favourable for Nortel. Equity investors should take heed; if the bonds holders don’t make it out at face value then the equity shareholders are generally holding a worthless investment.”

Thompson said with Nortel quickly running out of cash, time is a huge issue. He suggests Nortel has until the end of next year to execute on a turnaround plan.

Source: National Post

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