Sometimes, lessons come hard. For months, Nortel Networks Corp. (NT ) CEO John A. Roth told Wall Street that the telecom-equipment maker would sizzle in 2001, with more than 30% revenue growth. He made the bold prediction not once but three times since September. Then reality came crashing in. On Feb. 15, Roth announced that Nortel's revenues would be flat in the first quarter, at $6.3 billion--$2 billion shy of the company's previous estimate. The company's stock plummeted more than 35%, to less than 20 on the news. Still, Roth predicted that Nortel's revenue growth will accelerate the rest of this year, so 2001 revenues should be 15% more than 2000's $30.3 billion.
Deja vu, anyone? About 12 months ago, Nortel's archrival, Lucent Technologies Inc. (LU ), badly missed Wall Street's revenue estimates for a single quarter. Lucent CEO Richard A. McGinn said it was a temporary stumble that wouldn't keep his company from achieving 20% annual growth. Eleven months and four missed earnings targets later, McGinn is gone, and Lucent is still reeling. "It's a tidal wave," says BlueStone Capital Securities Inc. analyst Susan Kalla of the telecom industry's slump. "These tidal waves affect everybody."
Nortel included. The Brampton (Ont.) company doesn't have the gobs of problems that plague Lucent. Even so, Roth will be hard-pressed to meet that 15% growth target. Blame Nortel's most important customers, the telephone companies, which are ratcheting back spending on telecom gear. Kalla expects capital expenditures by major telecom companies to shrink 9% this year, to $113.6 billion, after a 17% jump in 2000. Nortel will fare better than the rest of the equipment industry because of its dominant share of the fast-growing optical market, but that probably won't be enough for Roth to meet the growth rates he's forecasting. Most Wall Street analysts are predicting a 7% to 12% rise. "Fifteen percent revenue growth seems very undoable," says ABN Amro Inc. analyst Ken Leon. "We see 10%--and think that's optimistic."
Nortel's earnings forecast may be even more optimistic. The company expects income before special charges to surge 10% this year, from $2.3 billion last year. But on Feb. 15, Roth said that Nortel will lose about $129 million in the first quarter, and he won't provide specifics on the profit outlook for each business unit. So the consensus analyst estimate is that profits will be flat this year. The 10% goal is "just ridiculous," says analyst B. Alex Hendersen of Salomon Smith Barney.
THE PLAN. Roth promises to have the skeptics eating crow one more time. He is, after all, the exec who transformed sleepy Northern Telecom into a Digital Age star with the most advanced optical gear anywhere. To meet that profit target, Roth plans to radically cut manufacturing costs by turning over production of low-margin voice products to contract manufacturers. He'll slice $1 billion in expenses by trimming 10,000 jobs and rolling back research-and-development spending to 12% of revenues, from 14% in 2000.
Roth is just as adamant that his revenue-growth goals are utterly doable. While the U.S. economy is struggling, Nortel expects regions outside of North America, which account for 35% of sales, to fuel the business. He thinks Nortel's wireless division can grow 20% this year because of the rollout of mobile services worldwide. And he predicts that Nortel's dominance in the optical-gear market will help generate robust sales growth even as telecom companies slow their purchases of other products. "We're going to ride this out," he says. "Other people may not be so lucky."
Confidence today can look like hubris tomorrow. This may be one of those cases. An examination of Nortel's four key business segments suggests that Roth will have a hard time keeping his vows.
-- The traditional telecom equipment business. This group sells the switches that direct voice calls to their proper destination, racking up sales of $6.5 billion last year. As AT&T (T ) and other phone companies shy away from the shrinking long-distance business, they're buying less old-fashioned voice gear and more equipment that handles data and Internet traffic. "People are stepping back," says Howard E. Janzen, CEO of Williams Communications Group Inc. (WCG ), a Tulsa (Okla.) telecom company. "Nortel is feeling the impact."
Meanwhile, the telecom upstarts that have been gobbling up telecom equipment for the past few years have suddenly lost their easy access to cash. Worse, the bankruptcies of ICG Communications Inc. and GST Telecom have scared off lenders. The result is that revenues for Nortel's traditional telecom business are likely to drop about 23%, to $5 billion, Leon estimates.
-- The local equipment business. This group will suffer from the tightening of capital markets, too. The division saw its sales soar 45% last year, to $10.1 billion, largely because local phone companies were buying equipment to connect their metro networks. But many of these small telecom players are slowing their purchases as cash dries up. Merrill Lynch & Co. expects capital expenditures by telecom upstarts to drop 25% this year, to $21 billion.
The other part of Nortel's local business is selling communications gear to corporations. Here, Nortel is a bit player compared with Cisco Systems Inc. (CSCO ), which has 59% of the market for the switches that direct data and Net traffic. Nortel's share: 8%. Nortel is introducing new products to gain ground this year, but its push comes as companies are slashing tech spending. The Commerce Dept. estimates that business purchases of communications gear will drop 2% in the first quarter, down from 65% growth in the first quarter of last year. All told, ABN Amro analyst Leon's estimate that revenues for Nortel's local business will rise 18% this year seems more likely than Nortel's forecast of 40%-50% growth.
-- The wireless business. This division will need a big surge this year to help boost overall sales growth. The company's goal is to push wireless revenues up 20% in 2001, to about $6 billion. To manage that, Roth is pursuing contracts for third-generation wireless networks, or 3G, which enable users to zap data and video from phone to phone. In the past nine months, Nortel has won more than $2 billion in multi-year contracts from six big players, including BT Cellnet and Spain's Xfera. Customers are buying Nortel's pitch that 3G services depend on connections to swift optical backbones--Nortel's strength.
But 3G may not take off as fast as Nortel hopes. In Europe, wireless players paid nearly $200 billion for new licenses and may not be able to afford much equipment before next year. In the U.S., 3G licenses may not even be available until 2004. That means that Roth's goal to hike Nortel's share of the global wireless market from 10% to 25% by 2003 is awfully ambitious. "That seems aggressive," says analyst Wojtek Uzdelewicz of Bear, Stearns & Co.
-- The optical business. What could save Roth is another stellar year in his optical unit. Last year, sales boomed 139%, to $10.6 billion, as telecom players snapped up the speedy gear. But this year doesn't look as promising because of cutbacks at major telecom companies. Level 3 Communications Inc., a major provider of Internet networks, will spend $3.4 billion this year, vs. nearly $6 billion last year. The result: Nortel's optical business is expected to grow 23% this year, to $12.5 billion.
Roth realizes that Nortel's optimistic targets will take a Herculean effort. After all, his optical juggernaut is as susceptible as any other business to economic malaise. "They will have to fight every single day to keep ahead," warns Fred Harris, Sprint PCS Group's director for network planning and design. So Roth might do well to adopt a more realistic view of how an unpredictable economy can cripple even the strongest competitors.
By Roger O. Crockett
Crocket writes on telecom and technology issues.