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Nortel: Material Margin Madness

Light Reading
News Analysis
Light Reading
7/27/2004

Nortel Networks Ltd. (NYSE/Toronto: NT) shares were shellacked this morning after the company said in a statement that it wasn't achieving its profit-margin goals (see Nortel Provides Status Update).

In morning trading, Nortel shares lost $0.59 (14.50%) to change hands at $3.48.

Today's curiously worded release could have easily set you off track – that is, unless you actually read past the second paragraph:

"The Company and NNL reported that there have been no material developments in the matters reported in their status updates of June 2, 2004, June 29, 2004, and July 13, 2004, with the exception of the matters described below," read the second paragraph of the release, part of a biweekly update that Nortel is providing the Ontario Securities Commission.

Of course, there were material developments. It was exactly the "matters described below" that caught investors' attention and gave the share price a 15 percent haircut. In the paragraph that followed, president and CEO Bill Owens had this to say:

"I remain pleased with Nortel Networks market momentum and continue to expect our revenues in 2004 to grow faster than the market (which we expect will grow in the low to mid single digits). However, as we move through 2004 and based on the work to date on our financial results, it is clear that our business model is not achieving our targeted operating cost (SG&A and R&D) performance of below 40 percent of overall revenues and our targeted gross margin percent of mid 40's."

Nortel said it is taking steps "to put into place an improved cost structure to optimize our financial performance." It also said it is working on its financial restatements and expects to "be in a position to announce" limited preliminary unaudited results for the first and second quarters of 2004 – and provide another update – in mid August.

In recent weeks, Nortel had already hinted that more cost-cutting might be needed to get the company back to healthy profit margins as it tries to move beyond the "accounting-challenged" tenure of ex-CEO Frank Dunn (see Nortel Gets Federal Subpoena, Dunn's Done With Nortel , Nortel Rattles Nerves). As highlighted in Headcount last week, Nortel's Owens provided some warning that something was up (see Headcount: Fair Warning).

What could lie ahead? When a company says "cost-cutting," it usually means layoffs. The only other options would be for Nortel to sell some assets or look for operational moves, but given its past extensive garage sales and recent restructuring deal to sell manufacturing to Flextronics Corp. (Nasdaq: FLEX), the most obvious moves have already been made (Nortel Sells Plants, Supplies Update and Nortel Sells Directory Biz). Of course, it could sell one of its four core divisions (Optical Networks, Wireline Networks, Wireless Networks, and Enterprise Networks), and there has been some chatter about this in the past. The wireless division would probably garner the most interest, but that's also what generates the most revenue for the company (about $1.4 billion per quarter).

— R. Scott Raynovich, US Editor, Light Reading


For more info on the state of industry financials, check out the coming Light Reading Live! event:

  • Light Reading's Telecom Investment Conference, in New York City, November 10.

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    dljvjbsl
    dljvjbsl
    12/5/2012 | 1:25:05 AM
    re: Nortel: Material Margin Madness
    From the article:

    Nortel said it is taking steps "to put into place an improved cost structure to optimize our financial performance."


    No prizes for guessing what this means - fewer cars in the parking lot at Carling and Moodie
    the_lord
    the_lord
    12/5/2012 | 1:25:05 AM
    re: Nortel: Material Margin Madness
    The first few rounds of layoffs may improve the stock price because it appears that management will start to shed unprofitable businesses.

    However, this has been the same story for the last 4 years. Bob Palmer, the DEC CEO in the 90's, kept asking himself when it was going to end with DEC. Well, it ended when they got bought by Compaq.

    Owens is right about a new cost structure must be put into place. The current cost structure was based off an extremely successful hardware platform. This hardware platform not only produced sales when a switch was sold; however, it increased sales in software, services, and consulting.

    The DMS is gone.... Now, a new business strategy must be adopted. Or, a new company must be created. John Roth was right about finding new market and platforms in the 90's. He just shifted the company too fast without isolating the new guard from the old guard.




    Stevery
    Stevery
    12/5/2012 | 1:25:05 AM
    re: Nortel: Material Margin Madness

    From the story, cost cutting often means layoffs.

    But don't layoffs usually mean a rise in stock price?
    No-tell
    No-tell
    12/5/2012 | 1:25:04 AM
    re: Nortel: Material Margin Madness
    Warning: following my advice will be neither quick nor easy, but it will result in lower costs.

    1. Reduce the number of products/product lines by either shutting them down or selling them off. This would be interesting: compare the NT product catalog today vs. the product catalog from 4 years ago. While there are new products, how many of the older products are gone? Few, I believe. Fact is that there is a certain fixed cost level needed to support any product line, regardless of product volume. So cut costs by cutting product lines. Yes, it's messy and there are obligations that will remain for a while, but it's a long-term fix. (Note that if anyone is going to be interested in acquiring a business from Nortel, that business will have to be marginally profitable or at least have a viable, believable path to profitability. No one wants to buy money-losing businesses; those businesses must be shut down.)

    2. Same goes for geographic scope. There's no virtue in being a global company, but there may be virtue in being a selectively global company. Sales in some areas surely don't justify the required administrative and legal costs of maintaining offices/employees/operations in those areas. Close them down and save the overhead.

    Bottom line: focus on where business has the greatest potential, both geographically and product-wise.
    goli95
    goli95
    12/5/2012 | 1:25:02 AM
    re: Nortel: Material Margin Madness
    I am not surprised; the only way Nortel has been able to compete lately is by giving products away. Look at how they have competed against Nokia in Cingular. In order to win a VOD project in a major MSO, they dropped their price from $7.5M to less than $2.3M.

    So, this news doesn't surprise me.

    whyiswhy
    whyiswhy
    12/5/2012 | 1:25:01 AM
    re: Nortel: Material Margin Madness
    Same old business strategy:

    How do we make money?

    Sales!

    How do we make sales?

    Cut the price!

    Price is less than cost?

    Increase sales!
    __________________________

    Look, the problem is many companies have a workable razor blade strategy: like Cisco.

    I am afraid NT does not.

    They keep killing themselves with the old "never breaks" core hardware quality paradigm.

    MSO's are used to repairing and repairing, because they design for CHEAP. That means only the minimum redundancy (if any), and the cheapest crap components on the cheapest boards in the cheapest racks they can find.

    Selling core-quality hardware in that market is a lose-your-shirt proposition.

    Better to sell the CHEAPEST piece of crap that works to the minimum specs, then make your money on replacing blades in the long run. As the blades age and burnout or just become obsolete, increase the price.

    -Why
    goundan
    goundan
    12/5/2012 | 1:24:58 AM
    re: Nortel: Material Margin Madness
    Nortel bid and won the recent $1B BSNL GSM bid in India for $75/sub for the whole kit and kaboodle from BTS to MSC to towers and diesel generators to billing systems to services. Nortel's AP business at this rate will be enough to flush their margins down the toilet in no time even after the proposed cost cuts.
    crm366x
    crm366x
    12/5/2012 | 1:24:53 AM
    re: Nortel: Material Margin Madness
    Quote:
    ...John Roth was right about finding new market and platforms in the 90's. He just shifted the company too fast without isolating the new guard from the old guard....
    ---------------------------------------

    I refuse to give Roth credit for anything. While, indeed in the late 90's he did recognise that telecom was changing, his response was the infamous "Right Angle Turn" by which he completely hollowed out the company to focus on just one market - optical. I am convinced that if the bubble had run a few more months he would have gotten around to trashing wireless -- one of the few bright spots in NT's present product portfolio. Furthermore, unlike Ciena (just as an example), Roth managed to exit the bubble without cash in the bank. Almost as a footnote, I'm told NT's last profitable year was 1998 (someone please correct me if I'm wrong). How on earth did Roth and Dunn manage to loose money during the height of the bubble? And then they made Dunn CEO after they bought Roth out? (As reported in SVN, Roth got a year-long leave of absence with pay when he left and furthermore, he was given a very significant raise just a few weeks prior to his leaving).

    I'm very sorry to say this, but I don't see an upside for this once-great company. No cash in the bank, no DMS cash cow to support ongoing R&D, massive talent loss, the increasing commoditization of the industry and increasing competition from offshore and lower cost suppliers. NT is simply too weak to execute a turnaround in today's market - and the mismanagement of the Dunn/Roth twosome contributed mightily to this weakness.

    It may not be much longer before someone else owns the parking lot at Carling/Moodie -- and that will be the very sad end of an era.

    X
    Yabba
    Yabba
    12/5/2012 | 1:24:51 AM
    re: Nortel: Material Margin Madness
    Author: No-tell Number:
    1. Reduce the number of products/product lines by either shutting them down or selling them off. This would be interesting: compare the NT product catalog today vs. the product catalog from 4 years ago.

    >> They have been trying to kill off the DMS-10 for a number of years. The problem is that there are so many of them installed, and they work so well, the customers love them. NT almost drove away this very loyal customer base by eliminating the sales staff and going to an 800 number. While the glory days of new CO sales are over, there is still substantial revenue available from the ILEC base.
    dodo
    dodo
    12/5/2012 | 1:24:43 AM
    re: Nortel: Material Margin Madness
    "At that time, Nortel is expected to outline plans to reduce costs, which could include job cuts and other restructuring. A number of scenarios have been outlined, such as combining optical gear with another division.

    Mr. Papageorgiou said he would not be surprised to see Nortel close its Brampton, Ont., headquarters and move its executive and financial employees to Ottawa, home to its core research and development"

    http://www.theglobeandmail.com...
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