Nortel's Bottom Sags

Citing ongoing weakness in U.S. carrier demand, Nortel Networks Corp. (NYSE/Toronto: NT) has lowered its breakeven point yet again, in what's become an ongoing effort to ride out the telecom downturn (see Nortel Lowers Outlook).

Nortel originally thought third-quarter 2002 revenues would be flat (see Nortel Falls Short in Long Haul). Now, it expects revenues to drop 10 percent. As a result, it must lower its quarterly breakeven level by 18 percent compared with last month's estimates, falling shy even of the skeptical expectations of at least one Wall Street analyst (see Nortel Still Not Slim Enough). The new level will be "below US$2.6 billion," Nortel says, from original estimates of about $3.2 billion.

To reach breakeven, Nortel must cut its workforce to a level of 35,000, down about 7,000 employees from the target it originally set for the end of the third quarter (see Nortel Falls Short in Long Haul and Nortel's World is Flat).

Nortel has cut more than 55 percent of its staff since January 2001, when it employed about 94,500 workers. Today's news brought Nortel's stock plummeting to $1.03, down $0.20 (16.26%) by early afternoon today.

Two key questions emerge: First, is this really the end of Nortel's cuts? Second, will it work?

Analysts aren't sure on either point. While many expected Nortel to lower its breakeven level, some thought it might not be as low as it's gotten (see Nortel Still Not Slim Enough).

"Going from $3.2 billion to $2.6 billion was pretty aggressive," says David Toung of McDonald Investments. "Will it be enough? I don't have a good answer for you."

"I'm not changing my outlook on the basis of a warning," says Kevin Slocum of SoundView Technology Group. "But I wish I could get inside how 35,000 is going to be better than 42,000. It's a long way from 95,000. I hope for the sake of the employees still there that it works. But who knows?"

Nortel seems stumped, too. Indeed, the news is the latest in a series of failed attempts Nortel's made to locate a breakeven it can live with. Over the past year, the company has been forced repeatedly either to offer no guidance or to correct its guidance downward mid-quarter.

At least one analyst thinks the company isn't pruning in the right places. "Nortel has cut buds, but it hasn't hacked away at the bush the way Lucent Technologies Inc. [NYSE: LU] has done," says Frank Dzubeck, president of consultancy Communications Network Architects.

Lucent, too, has cited the need to cut another 7,000 jobs (see Lucent Loses $7.9B, Plans Layoffs). But Dzubeck sees big differences in how the two companies have approached their problems over the past year. Dzubeck thinks Nortel needs to be more aggressive in looking at its asset pool and making some informed changes.

"Nortel thought it had done well to sell its access business. But that business wasn't making money anyway," he says (see Zhone Acquires Nortel's Access Gear).

And while Nortel's winning business, particularly in the voice-over-IP space, it continues to be haunted by old acquisitions (see Whatever Happened to X? page 6), Dzubeck says. Bay Networks, for instance, continues to represent a large installed base of switches and routers for Nortel. But even though that portion of Nortel's enterprise business may bring in cash, it's likely not worth the ongoing drain on resources required to maintain the installed base, he maintains.

Further, Nortel's debt situation remains in question. "[Lucent CEO] Schacht spent his whole first year just straightening out Lucent's debt," Dzubeck asserts. "That's what [Nortel CEO Frank Dunn] should have done. Nortel's debt versus cash in hand is a major problem."

Dzubeck also notes that Lucent spun out Avaya Inc. (NYSE: AV) and Agere Systems (NYSE: AGR) in a more or less timely fashion, while Nortel continues to have problems shopping its components and wireless businesses. Further, given current market conditions, it's getting less likely that Nortel will be able to fetch a good bid for its components assets (see Components Overboard!).

Clearly, it remains to be seen whether Nortel's latest changes will achieve the hoped for result.

— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com