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Will Nortel be a 'great company' again? Mike Z. says 'Yes'

Mike Zafirovski (Nortel photo)

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Editor’s note: This is the second in a three-part series about where troubled telecom gear-maker Nortel stands in the recovery effort led by CEO Mike Zafirovski. The reports were written by Mark Evans, a veteran Toronto technology and telecommunications journalist who covers Northern Telecom in a blog. Nortel employs some 2,200 people at its Research Triangle Park, N.C., campus. Evans also is a frequent contributor to WRAL Local Tech Wire with coverage of NT.

TORONTO — Ever since Mike Zafirovski was hired as Nortel’s president and chief executive officer in October 2005, he has been insistent and persistent in his belief that the telecom equipment supplier can become “a great company” again.

He has maintained this bullish stance even as Nortel (NYSE: NT) has gone through a messy and expensive accounting scandal, eliminated thousands of jobs, experienced several money-losing quarters and seen its stock price drop by about 75 percent since Zafirovski took the helm from ex-U.S. Adm. Bill Owens.

While Nortel is a long way from being great again, there are indications the worst may be over. Nortel may never be a Tier 1 supplier again, but it could establish itself as a profitable, focused player – something that would earn Zafirovski – called Mr. Z and Mike Z. for short –- a lot of respect.

As Zafirovski attempts to steer Nortel to higher ground, one of the biggest challenges is that the competitive landscape has been treacherous. At best, industry growth has been modest because competition from established players such as Cisco and Alcatel-Lucent, as well as emerging suppliers such as ZTE and Huawei, has put major pressure on operating and profit margins.

Amid this difficult landscape, Duncan Stewart, president of Duncan Stewart Asset Management, said Zafirovski has done a good job of making sure Nortel has a sensible business plan focused on a few areas.

A core part of Zafirovski’s approach to get Nortel back to being competitively viable has been slashing costs with the goal to reduce operating expenses by $1.5 billion.

This has seen facilities around the world closed – the latest casualty being a 400-person research and development facility in Calgary, Alberta; thousands of jobs eliminated or moved to lower-cost regions such as Mexico, Turkey and China; and business units sold, such as the GSM/UMTS division to Alcatel-Lucent.

More than anything, Zafirovski has stabilized Nortel after a tumultuous period in which the company shrank from 100,000 employees to 30,0000 while going through three CEOs – John Roth, Frank Dunn and Owens.

Analyst: Zafirovski Is ‘not a vision guy’

Among Zafirovski’s biggest accomplishments has been overhauling the company’s senior management team. Over the past two years, he has recruited well-regarded people from Jupiter Networks, Marconi, IBM and General Electric – the company where Zafirovski spent 20 years before moving to Motorola Inc.

“The new management team at NT includes an impressive array of former GE executives, longtime Nortel folks and some new recruits from IBM and elsewhere,” Paradigm Capital analyst Barry Richards said in a research report.

“This seems to be the ideal group for the task at hand. This team has delivered seven straight quarters of improved operating income (year over year), and trends on revenues, gross margins, operating expenses and profitability are all positive. “

Chris Umiastowski, an analyst with TD Securities, said Nortel’s management team has been able to implement an “overwhelming cultural change”.

“We have never before seen Nortel possess such strong focus on profitable execution of its business plan, which we attribute to the GE culture brought in by Zafirovski and other members of the senior executive team,” he said.

Zafirovski’s moves over the past 2½ years may have gone a long way to getting Nortel back into fighting shape, but many analysts have been frustrated by a lack of strategic vision and a plan for Nortel to find businesses with strong growth potential.

“One of things that’s been pretty clear is that Mike Zafirovski is an execution and operations guy,” Stewart said. “Zafirovski is not a vision guy.”

A year ago, for example, Wi-Max was positioned as a major strategic and growth area. Nortel, however, has for all intents and purposes bailed out of the Wi-Max business after signing a joint venture last month with Tel Aviv-based Alvarion, which will now supply Wi-Max equipment to Nortel customers. Meanwhile, Nortel has become bullish about LTE and 4G.

Margins for Success

Another area where Zafirovski still has to show progress is Nortel’s financial performance. At a time when revenue growth will be, at best, modest, Zafirovski is insisting Nortel will be more profitable. In particular, he believes the company will be able to improve operating margins to 13 percent within the next few years, compared with the 8 percent to 9 percent analysts expect in 2009.

Stewart points out that Nortel has never had 13 percent operating margins and questions whether this is do-able, given the telecom market’s competitive volatility and the fact that profit margins continue to be under attack as the different players scramble to maintain market share.

For investors, the most obvious area in which Zafirovski has failed to perform is the company’s stock price. Since he joined Nortel, the stock has dropped by about 75 percent – a situation that Zafirovski concedes is “unacceptable.”

As a key barometer to assess his performance, Zafirovski would no doubt like to see the stock price improve in a major way.

Of course, this will depend to a large degree on whether his strategic plan to revive Nortel bears fruit. While there are signs that progress is being made, the jury is still clearly out on Nortel and Zafirovski himself.

The latest update comes on Friday, when Nortel reports its latest quarterly earnings – or lack thereof.

Wednesday: What’s in the Nortel technology portfolio?