TDM and VOIP

March 23, 2006

For millions of investors, lenders and customers, the name Nortel is synonymous with failure, not innovation

STEVE MAICH

In business, as in life, it's best to avoid overt signs of desperation if at all possible. Everybody knows never to let 'em see you sweat, but there is a key exception to this rule that is rarely discussed and often overlooked, generally with dire consequences. Acting desperate is excusable, even advisable, when you actually are desperate, and everybody knows it.
In those cases, who really cares how you look? The thing that matters is survival. There are no points for style in survival situations. When a freighter goes sailing by your leaky lifeboat, playing it cool can be fatal.

Which brings us to Nortel Networks Corp., and the many reasons why it is now time to relegate the company's name, logo and branding to the history books, and begin again. Go back to Northern Telecom if you like. Heck, call the company Acme Corp. for all it matters. The point is, CEO Mike Zafirovski was brought in last year to be an agent of change at a company adrift. They paid US$11.5 million to Motorola to get him. He has a new board, a new CFO and an extremely ambitious plan. To make it happen, he needs to make a dramatic break from the past -- the sooner the better. But that's proving difficult.

Two weeks ago, Nortel revealed that it will be restating its financials for the third time in less than three years, due to yet another accounting error. Unlike its last restatement, this one likely won't trigger subpoenas from the cops, so that's at least one positive. But still, the psychological impact of yet another misstep is huge. To the millions of skeptics out there, it was a reminder that this is the same old Nortel, up to the same old pratfalls that ceased to be funny a long time ago.

Would a new name really substantively change anything within the company? Not really. Would critics deride it as meaningless and superficial? Probably. But whether we like it or not, the world of business is driven by human beings, who respond to symbolism. For millions of investors, lenders and potential customers, the name Nortel is synonymous with failure, not cutting-edge technology. Zafirovski has embarked on the biggest challenge of his professional life, and at the top of every letterhead is a bit of dead weight he can ill afford. In this game, little details mean a lot.

Consider the mountains in his path.

The latest accounting problem, and the fact that Nortel will have to delay filing its annual report to regulators, has several implications, none of them good. As of now, Nortel is technically in default of its US$1.3- billion credit facility. Lenders could, if they choose, demand accelerated repayment or claim company assets as collateral. Export Development Canada, which has given US$750 million in support, could cut off further funding or terminate existing commitments. The New York Stock Exchange could boot the company's shares off the Big Board.

Any of the above could be a death blow for Nortel at this point. The good news is, none of these things are very likely to happen. Lenders have been down this road before with Nortel, and it really isn't in their interest to drown the company. They're much more likely to issue waivers and let Nortel get back on its feet. Still, the risks are real, and they are only part of a much larger challenge.

Last month, Zafirovski laid out a plan for Nortel's future, indicating that he wanted to focus efforts on businesses in which Nortel could be an industry leader, with at least a 20 per cent share of the market. According to Merrill Lynch analyst Vivek Arya, just four of Nortel's 14 primary business groups currently meet the boss's 20 per cent threshold. Last month, Tom Astle, an analyst with National Bank Financial, looked at nine business lines where Nortel is a laggard, and concluded the company had the potential to become a major player in only three or four of them. He suggests Nortel should probably be selling or shutting down the rest.

Zafirovski has also indicated he wants to improve Nortel's operating profit margin enough to wring an additional US$1.5 billion in profit by 2008. Analysts estimate this means an operating profit margin of close to 15 per cent. To put that in perspective, Nortel's operating profit margin in the last quarter of 2005 was 6.4 per cent. Nortel's main competitors, Lucent Technologies and Alcatel, both have operating margins of around eight to 10 per cent. In short, Zafirovski has set for himself a monumental hurdle. What's more, analysts say current forecasts for the company do not include the $2.7-billion settlement offered recently to shareholders to resolve allegations of executive malfeasance under the previous regime. That could carve about three cents a share from profits this year and next.

The whole strategy hinges on the CEO's ability to cut costs and jettison weak business units without reducing profits. It's tantamount to trying to get a canoe to move faster by throwing paddlers overboard. Not impossible, but tricky, to say the least. As Merrill Lynch's Arya said in a report to clients last week, "if the new CEO can cut costs aggressively, enter new growth areas through mergers and acquisitions, or win a marquee contract, investor attention could rekindle." And if he could pull a rabbit or two out of his hat while he's at it, then we'd really be impressed.
Yes, a name change is a desperate move, but it has worked in the past. WorldCom broke ties with its scandalous past by reverting back to the name MCI. Tobacco giant Philip Morris put a happier face on its business by adopting the name Altria. Suzy Shier changed its name to La Senza when its focus shifted to lingerie.

It's not a panacea. It won't get the profit margins up. But it'll send a message that the past is the past. And if Zafirovski plays his cards just perfectly, he can dream of a day when people forget about Nortel, for all the right reasons.M

To contact the writer, email steve.maich@macleans.rogers.com
To comment, email letters@macleans.ca