For those of you who don’t have a WSJ subscription, here’s the story on Nortel that appeared in yesterday’s newspaper.
TORONTO — As Nortel Networks Corp. reported its seventh loss in the past nine quarters, Chief Executive Mike Zafirovski mapped out a plan to get the company’s bottom line back in the black.
Mr. Zafirovski says the telecommunications-equipment vendor will slash spending on materials, cut research-and-development spending to around 15% of revenue from about 18%, and halve key administrative costs. The company moved into a scaled-down Toronto headquarters in late September. Nortel says cost-cutting will save some $1.5 billion a year by 2008.
The company also expects new product offerings to boost profit margins. Mr. Zafirovski last week told reporters that Nortel is on a “path to improved profitability.”
But it remains a rocky road. Earlier this month Nortel reported a third-quarter loss of $99 million, even though revenue climbed 17% to $2.96 billion. The results triggered an 11% drop in the company’s long-slumping stock price.
The telecom-equipment market suffers from “too many vendors and too little business,” says Ping Zhao, a senior analyst with research firm CreditSights. “The pricing environment is not getting better,” she says, because telecom carriers expect revenue-hungry vendors to reduce prices to secure business.
Nortel says its problem is that profit margins on its most recent products — such as Internet-protocol calling equipment and next-generation wireless networks — haven’t been as high as those on earlier switching gear and other equipment.
But Mr. Zafirovski says low margins are typical for new technologies, and profit will climb as the new products mature and proliferate. He says the company still aims to boost its operating-profit margin to a double-digit percentage by 2008, from about 1% in the third quarter.
Some equipment providers have responded to the industry pressures by combining forces, most notably Lucent Technologies Inc. and France’s Alcatel SA, whose merger is nearing completion. But analysts note deterrents to potential suitors in a linkup with Nortel. Among them: The company’s debt load stood at $4.4 billion at the end of the third quarter, while operating cash flow has remained negative this year. (Its cash holdings were $2.6 billion as of Sept. 30.)
And Nortel still faces regulatory probes in the U.S. and Canada tied to an accounting scandal. In any event, Mr. Zafirovski has said he isn’t in favor of a combination of Nortel with another big equipment vendor.
Analysts say Nortel will have difficulty reaching its operating-profit-margin target. Some question whether Nortel’s traditional customers — big North American phone companies — will install new gear fast enough to help the company meet its goals. “The big phone companies don’t want innovation. They want to maintain what they’ve got” and protect their profits, says Michael Urlocker, a Toronto management consultant and former technology analyst.
John Roese, Nortel’s chief technology officer, argues that phone companies realize they must invest in new technologies or risk being crushed by competitors that do. By the second half of next year, he says, Nortel will begin to see revenue from fourth-generation wireless technology, which sharply boosts bandwidth capacity to provide such services as high-quality video.
Other Nortel R&D efforts are producing needed technologies, Mr. Roese adds. A new optical-networking technology allows fiber-optic lines to carry data over longer distances with less electronics and construction costs, he says. An alliance announced in July with Microsoft Corp. to provide software-based business-communications products is now producing revenue, he says.
Nortel has also learned to say no. Unhappy with the expected returns, Nortel recently dropped out of the running for contracts in Pakistan, South America and Spain, Mr. Zafirovski says, and in two of those cases declined invitations to match the lowest bids to win the business.
Sticking to profitable business may seem elementary, but it hasn’t always been so at Nortel. The company lost hundreds of millions of dollars on a wireless-equipment contract in India, while trying to get a foothold in that growing market. That contributed to Nortel’s loss of $105 million in last year’s third quarter.
Mr. Zafirovski, who was hired last November from Motorola Inc., says it will take three to five years for the “re-creation of a great company.” Nortel paid Mr. Zafirovski $24 million in compensation last year — including a payment to settle a contract dispute with Motorola — plus millions more in stock and options. Nortel shares have sunk about 30% during his tenure; on Wednesday they were up three cents at $2.14 as of 4 p.m. in New York Stock Exchange composite trading.
“We’ll be fighting vigorously for new business,” Mr. Zafirovski says, but unless Nortel sees solid profits, “we’re going to walk away from it.”