Sour Grapes of Roth

Isn’t the customer always right? It appears that at least one top telecom exec has forgotten that old adage.

Last Friday, John Roth, chief executive officer for Nortel Networks Corp. (NYSE/Toronto: NT), pointed his finger directly at customers to justify why his company will report a $19.2 billion loss this quarter (see Nortel's Nuclear Winter).

Less than a week later, Joseph Nacchio, CEO and chairman of Qwest Communications International Corp. (NYSE: Q), gave the finger right back to Roth (see Qwest Gives Market a Boost).

During a conference call with analysts, Roth contended Internet traffic had fallen off considerably this quarter, into the single digits, due to Internet service providers that had gone out of business. He implied that, as a consequence, Nortel product sales declined.

“We’ve seen a reduction in traffic as a number of companies declaring chapter 11 have gone away,” said Roth. “Those loads haven’t been replaced, as people haven’t been reconnected.”

His comments set off a firestorm among carriers and prompted Nacchio to take a public stand. In a conference call on Tuesday, Nacchio blasted equipment providers for blaming their woes on a slump in Internet traffic. Though Nacchio didn’t name Roth or Nortel outright, it was clear to whom he was referring.

“I was particularly annoyed that some of the equipment manufacturers are claiming negative growth in Internet traffic,” he ranted. “I’m not sure what they’re talking about because our Internet traffic is up 46 percent quarter over quarter, and when we look at our private peering arrangements, which we have with all the other big carriers, we see their traffic is up also.”

Nacchio went on to say that Qwest has actually lit more optical capacity for revenue in the second quarter of this year than it had for the entire year in 1998, emphasizing that it only lights new fibers when traffic demands warrant it. In his statements, Nacchio urged equipment providers to look in their mirrors to find the answers to their financial woes.

“The problem the equipment folks have is an industry structural condition coupled with some economic slowdown,” he said on the call. “It is not that there are U.S. networks operating at 3 to 5 percent of capacity. So I think the utilization, the capacity question, the blunt issue is dramatically overplayed.”

Roth’s comments didn’t go over too well with analysts either, who say that Nortel has no one else to blame but itself for its failings. These analysts point to a number of issues all within Nortel’s control.

The company has tried to build out its new optical networking and wireless businesses through a series of expensive acquisitions that have cost the company about $12.3 billion in charges, according to figures presented on the conference call. The company is also still relying heavily on its legacy circuit switch business, which has seen a stark downturn over the last few quarters.

And then there is the issue of vendor financing, a practice that has also caused financial problems for Nortel’s archrival, Lucent Technologies Inc. (NYSE: LU). As competitive local exchange carriers (CLECs) have gone out of business, they’ve defaulted on payments, using Nortel’s balance sheet to sop up the mess and costing the company some $200 million in writeoffs.

“It’s classic Big Company syndrome,” says one analyst who didn’t want to be named. “They’re just looking for a scapegoat. Blame the customers -- or the customers’ customers, as the case may be. It’s a joke.”

The real issue is not that Internet traffic has declined or that there is a glut of capacity in the network. It's that carriers are being more careful with their cash and, consequently, are making more efficient use of their current gear, say analysts.

“If there’s a glut of anything, there’s a glut of dark fiber,” says Rick Schafer, an analyst with CIBC World Markets. But carriers are being more careful in how they spend the money to light that fiber, he adds. “The pendulum has shifted, and carriers are trying to reduce their upfront costs by scaling back deployments of new systems.”

Roth acknowledged this phenomenon on the call as yet another cause for Nortel’s big losses this quarter. He said that the slowing economy has forced many carriers to use existing equipment more efficiently than they have in the past. This means that they are redeploying gear in different parts of the network and reconfiguring old equipment to squeeze as much revenue out of it as possible.

“When the name of the game moves from capital investment for pursuing revenues, to one that focuses on return on capital, it’s a huge paradigm shift,” said Roth. “Unfortunately for us, our customers' engineers are getting very good at this, and they’re finding opportunities everyday for avoiding ways to spend capital.”

- Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.com