By Olga Kharif
December hasn't brought the telecommunications-equipment business much holiday cheer. On Dec. 13, optical gearmaker Lucent Technologies (LU ) preannounced a wider-than-expected loss and a revenue shortfall of at least $1 billion for its 2002 first quarter, which ends Dec. 31. Also on Dec. 13, former optical star Ciena (CIEN ) revealed that its first-quarter revenues could fall by as much as 40% compared with the fourth quarter of 2001 (see BW Online, 12/19/01, "At Ciena, the Worst Is Yet to Come").
A small ray of sunshine penetrated the gloom on Dec. 21, however. Nortel Networks (NT ), the No. 3 player in the business -- and the first to take a drubbing, nearly a year ago -- preannounced a smaller fourth-quarter loss than analysts had been anticipating. Excluding one-time charges, it said its final-period, pro-forma net loss should come to 16 cents a share instead of the 18 cents analysts had predicted. And its revenue shortfall for the quarter will be much less than Lucent's -- about $100 million, meaning that Nortel's fourth-quarter revenues should total about $3.4 billion.
The announcement is a sign that Nortel's business may have begun to stabilize -- and just in time. Within the past month, Wachovia Securities and RBC Capital Markets have downgraded the stock, and most analysts polled by Thompson Financial/First Call now rate Nortel a hold. Its shares fell by nearly 24% from from $8.80 on Dec. 7 to $6.40 on Dec. 20. After it announced its fourth-quarter projections, its stock rose 79 cents, to close at $7.15 on Dec. 21.
Even so, what Nortel mainly has going for it now is staying power. It had $3.4 billion in cash as of Sept. 30. That should be enough to sustain it if SoundView Technology analyst Kevin Slocum is right in saying that "we are probably at the worst point or just past the worst point" of the down cycle for telecom-equipment companies. Should the bottom be here, Nortel's low valuation might make it attractive for investors with an appetite for risk, says Paul Sagawa, an analyst with Bernstein Research.
Nortel's biggest problem will likely be continued weak demand. Infrastructure spending by phone companies and Internet service providers in North America is expected to decline 20% in 2002, on top of a 20% drop this year. Nortel's revenues, which declined about 41%, to around $17 billion, in 2001, will fall a further 13%, to $15.9 billion, in 2002, predicts Shayna Malnak, an analyst with Williams Capital Group.
Next year will be kinder to Nortel than to Lucent, whose annual revenues could plunge by one-third, to $13.5 billion, estimates Malnak. But that will be small comfort if the market for optical equipment doesn't experience an anticipated recovery by the second half of 2002.
If the drought continues beyond that, Nortel could face a cash shortage and credit-rating problems, says Martin Pyykkonen, an analyst with C.E. Unterberg, Towbin. In its Dec. 21 announcement, Nortel said it had renegotiated its $2 billion credit line, cutting it to $1.58 billion but extending it through the end of 2002. That's a sign that it's working on strengthening its cash position, says Malnak. Nortel declined to comment for this story.
The company's other problem, according to analysts, are major holes in its product portfolio that are being filled by competitors such as Cisco Systems (CSCO ). Pyykkonen points out that most telecom carriers now want Internet protocol-based equipment rather than the traditional, circuit-based gear that accounts for 15% to 20% of Nortel's total business. IP equipment sends data and voice traffic in bits and pieces and allows service providers to better manage their fast-growing Internet traffic.
The voice-over-IP equipment market, which reached $1.7 billion in 2000, is estimated to have almost doubled this year, to some $3.3 billion, according to Telecommunications Industry Assn. The TIA expects the market to increase to $11.6 billion by 2004.
While Nortel, with $2 billion in future contracts, is a player in this market, "Cisco has got more of the bells and whistles," says Pyykkonen. Cisco also has a 50% market share, according to research firms InfoTech and Synergy Research Group.
Nortel faces the same problems with its corporate-customer portfolio. Those products include routers and switches used to direct data and voice calls across the networks of large organizations. That market is growing and many customers would like an alternative supplier to Cisco, but in recent years Nortel has let its product portfolio lag behind its rivals, says Jim Slaby, an analyst with Giga Information Group.
As a result, many potential customers have had little choice but to go to Cisco. Unless Nortel pays more attention to this market, which accounts for an estimated 10% of total annual revenues, it might as well get out of that business and concentrate on its core competency of serving phone carriers and Internet service providers, says Slaby. However, with that market expected to decline in the next year and possibly beyond, Nortel is likely for now to stay in any business that generates significant revenues.
Nortel has several strengths, however. It has been one of -- if not the -- most aggressive telecom companies in terms of cutting costs. By the yearend, the Brampton (Canada) company will have laid off 27,000 employees -- 36% of its total -- and written down roughly $12 billion in assets. Nortel's management team is complete now that experienced insider Greg Mumford has was promoted to chief technology officer on Dec. 17.
Nortel has introduced a new product used to send high volumes of voice and data over long distances, becoming the first direct competitor to a similar product from Ciena. The company also is racking up sales of voice-over-IP switches that are used to move calls and data through telecom networks. While dollar volumes are still low, Nortel has about $2 billion in contracts for such equipment with the likes of Qwest Communications (Q ).
Those products could increase Nortel's share of this market from about 7% this year to 20% next year, estimates Woo. Worldwide sales of this gear are expected to grow from $104 million in 1999 to $4.3 billion by 2004, according to marketing consultancy Yankee Group.
Still, these markets, even combined, aren't big enough "to turn a death spiral into a growth story" for all of Nortel, says SoundView Technology's Slocum. That's bad news, since Nortel's market share in optical networks has declined from 47% to 15% in the past year, estimates Shin Umeda, an analyst with networking consultancy Dell'Oro Group in Redwood City, Calif. Nortel lost so much share because it sold a big chunk of its equipment to emerging carriers, many of which have finished building out their networks or have gone out of business, explains Umeda.
All of its troubles notwithstanding, Nortel is "ready to start making a run back up to profitability again," declares Giga's Slaby. But, he adds: "They are going to limp along, not fly along." At least limping beats being out the game altogether.
Kharif covers technology for BusinessWeek Online in Portland, Ore.