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The telecom gear maker's planned sale of a fast-growing business could presage a breakup of the company—or give it the cash it needs
Wall Street securities firms aren't the only bearers of bad news these days. On Sept. 17 telecom equipment maker Nortel (NT) trimmed growth forecasts and said it's likely to announce cost-cutting measures such as staff reductions.
Most troubling for investors who pummeled Nortel stock, slicing 47% off its market value, was the announcement that Nortel may sell one of its fastest-growing businesses. Nortel CEO Mike Zafirovski said he may flog the Metro Ethernet division, which makes gear that delivers broadband within cities. The business accounts for about 14% of Nortel's total sales, and is "one of the faster-growing [market] segments," registering a 10% compound annual growth rate, Mark Sue, managing director at RBC Capital Markets, wrote in a Sept. 17 research note.
Analysts viewed the potential sale of one of Nortel's growth engines as a harbinger of more sales; some said it may even presage a complete dissolution of the company. "The fact that they are weighing the sale is giving the impression of a lot more trouble," says Richard Windsor, an analyst at Nomura Securities.
A Widening Loss
Nortel is struggling amid an economic slowdown that's causing customers to delay telecom equipment purchases. The company is also losing share to rivals such as Huawei that can sell products at a lower price. Other telecom equipment makers including Alcatel-Lucent (ALU) face similar challenges (BusinessWeek.com, 9/2/08), but Nortel appears less well-equipped to manage them, says Stephane Teral, an analyst at consultancy Infonetics Research. "Nortel is the weakest of all these [large] players," he says. Nortel's second-quarter loss widened to $113 million from $37 million a year earlier.
Investors and analysts are concerned that a multiyear effort to stem losses and revive growth isn't paying off. Some are beginning to wonder whether Zafirovski may conclude the company is better off sold in pieces. "Nortel has entered a very difficult period that's not likely to get better," says Duncan Stewart, president of Duncan Stewart Asset Management, which doesn't hold Nortel shares. "It's going to be sold or dramatically restructured before Christmas." George Riedel, chief strategy officer at Nortel, says breaking up the company wouldn't be in shareholders' interests. "The market sees through things like that," Riedel says in an interview. "It's difficult to see you'd create real value."
On Sept. 17, Zafirovski did hint he might want to find a partner for next-generation, 4G wireless technologies. The move would lighten Nortel's management load of business that's considered risky but also potentially lucrative in the coming years.
Who may buy the Metro business? Buyers could include Cisco Systems (CSCO) or Ciena (CIEN), though the latter may need to join up with others to raise sufficient funds. "We have had some early conversations with a couple of folks," Riedel says, without identifying any possible purchasers. "I think the interest is going to be strong." Cisco didn't return a request for comment. Ciena didn't address Nortel talks directly. "[Mergers and acquisitions have] been a piece of our strategy from the start and will likely continue to be as Ciena evolves," Ciena spokeswoman Nicole Anderson wrote in an e-mail.
A sale is far from certain, however. The Metro Ethernet division may have lost market share in 2008, according to consulting firm WinterGreen Research. Selling any business is tough nowadays. Earlier this year, Nortel was rumored to be in talks to combine its wireless unit with that of troubled Motorola (MOT). Those talks have so far not borne fruit.
If Metro Ethernet does sell, it could generate $1 billion to $1.5 billion, Windsor estimates. That would boost Nortel's cash hoard by 30% to 50%, helping the company keep other businesses afloat, analysts say—though Nortel says its cash position is "solid" and that the next big debt payment isn't due till 2011. Nortel also says it's not subject to performance-related debt covenants that could trigger an early repayment of debt.
It could also carry Nortel through to next year, when some analysts say at least some areas of telecom gear spending may pick back up. U.S. wireless carriers' spending dropped 6%, to $20 billion this year, but it may increase a few percentage points next year, says Skyline Marketing Group. "The next wave is going to be wireless," says Teral of Infonetics. And while most analysts only expect mass deployments of next-generation wireless technologies such as Long Term Evolution in 2011 or 2012, Nortel believes they may actually happen before then. "We are having early trial discussions, and now carriers are pulling these investments out sooner," Riedel says.
For this troubled company, the purchases couldn't come soon enough.