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APRIL 29, 2004
By Olga Kharif Maybe Nortel Can Untangle the Wires Though more trouble could be coming, replacing its top execs is the telecom-gear vendor's key first step in regaining credibility When Nortel Networks (NT ) dropped the bombshell early on Apr. 28 that it's replacing its top management team, perhaps that shouldn't have come as such a shock. The telecom-equipment supplier had previously announced internal and then Securities & Exchange Commission investigations into its financial results. Yet when it said it was "terminating" CEO Frank Dunn and had already suspended its CFO and controller, its shares plummeted. In a day, the stock fell 28.2%, to $4.05, the lowest point since last November. Many figure the Nortel empire may be crumbling since the announcement also included plans to restate net profits for 2003 downward by 50%, to $366 million, and it cautioned that further restatements are likely. This follows Nortel's December restatement of results for 2000 through the first half of 2003 to fix incorrect accounting of certain liabilities. Nortel continues to delay announcing this year's first-quarter results. At this point, it's impossible to model profitability for 2004, says Michael Mahoney, portfolio manager with EGM Capital funds in San Francisco. On Apr. 28, Standard & Poor's credit rating agency cut its junk rating on Nortel debt to B-minus, from B. Most analysts are suggesting that investors steer clear of the situation until Nortel's financial picture becomes clearer. "BLAND AND SAFE." However, some experts point out that Nortel may be at -- or near -- its lowest point, and that could appeal to investors willing to gamble. New CEO William Owens has an impressive record: He's the founder of Extend America, a five-state wireless service provider -- and wireless is one of Nortel's biggest growth engines today. Before diving into the business world, Owens was vice-chairman of the Joint Chiefs of Staff, the second-highest military rank in the U.S. He played a key role in restructuring the armed forces after the Cold War and in bringing advanced technologies into the military. Owens could potentially be an asset to Nortel in snatching up government contracts, says Sam Greenholtz, a Westminster (Md.)-based co-founder of consultancy Telecom Pragmatics. Most important for Nortel, "he's bland -- and he's safe," says Greenholtz. "They want to get the attention off of their company and their board." Yet the ongoing investigations could make it hard for Nortel execs to concentrate fully on the brutally competitive environment the next few quarters. The Canadian company isn't facing just a probe by the SEC but also by the Ontario Securities Commission. And Owens could have one potential drawback. Before his appointment, he used to head Teledesic, a Bellevue (Wash.) concern building a satellite telecommunications network -- and satellite is neither Nortel's core expertise nor a major strategic focus. REBOUNDING DEMAND. Owens may have a bit of time to get up to speed. Nortel's customers won't stop buying its gear because of an accounting scandal and leadership overhaul, believes Greenholtz. The outfit's telecom clients have long used Nortel's legacy equipment -- and switching to another vendor would be both technologically complicated and prohibitively expensive. Some experts point out that the financial restatements, while significant, relate to past revenues, which Wall Street doesn't much care about. And analysts do seem to agree that Nortel's sales should increase this year. A rebound in demand for telecom equipment as the economy improves is boosting revenues. On Apr. 23, Ericsson (ERICY ) reported first-quarter revenue growth of 9% year-over-year. Rival Lucent (LU ) reported the same percentage year-over-year sales increase on Apr. 20. And Juniper's (JNPR ) first-quarter sales jumped 43% vs. the year before. Nortel may not see that big a leap because it sells different products. Still, it's better positioned in many markets than Lucent, says Mark Lucey, an analyst with TD Securities. For example, Nortel is stronger in the red-hot area of IP (Internet protocol) telephony -- networks that can handle both data and voice calls. That market is among the fastest growing in the telecom-equipment sector. This year it's expected to expand 56%, to $1.75 billion, from $1.1 billion in 2003, according to tech consultancy IDC. RESTORING TRUST. Also, Nortel has a wider product portfolio and is gaining more customers -- including Verizon (VZ ) -- than Lucent in this market. Nortel is seeing lots of demand from corporate customers, which hope the technology can help sharply reduce telecom bills. Not to minimize the seriousness of the situation Nortel is facing, but ousting the management team in one fell swoop could be the fastest way for it to begin restoring credibility with investors and customers. "Under new management, Nortel could start to restore trust," says John Ryan, president and founder of telecom consultancy RHK. However, "once the trust is violated...it takes a long time to get it back." The road will be long and rocky. Printer giant Xerox (XRX ), for instance, took two-and-a-half years to make all of its restatements following an accounting scandal. And in the spring of 2002, after they were completed, the SEC slapped Xerox with a $10 million fine. Still, Xerox is also an example of a company that has restored its image and its product line. And perhaps Nortel has taken an important first step on that same path.  Kharif covers technology for BusinessWeek Online in Portland, Ore. Edited by Beth Belton
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