In the wake of Nortel’s profitable third-quarter results, the mood among analysts, investors and, for that matter, the media has been decidedly optimistic.
Nortel (NYSE: NT) shares jumped 18% after the company posted its results; several analysts upgraded their ratings and target prices; while BusinessWeek published a story entitled “Finally, Good News from Nortel”.
All these positive developments are a stark contrast to the dark clouds that have loomed over Nortel in recent years as the Canadian telecom supplier struggled through an accounting scandal, class-action lawsuits, a senior management overhaul, thousands of layoffs, and a series of disappointing financial results.
Not surprisingly, Mike Zafirovski, Nortel’s president and chief executive who this month celebrated his second anniversary on the job, was pretty buoyant during a conference call with analysts.
“We are learning how to partner better, and based on the market and what we’ve seen from everyone else, we do think both the Q3 results and what we are showing for Q4 should give investors the confidence the management team is playing cards we have, playing them well, and obviously trying to improve the cards we have for the future,” he said. “There is a passionate pursuit for making Nortel very relevant and achieve superior results.”
Nortel’s third-quarter performance, which featured a profit of $27-million on sales of $2.7-billion, clearly made a good impression on Credit Suisse analyst Paul Silverstein, who upgraded Nortel to “neutral” from “under-perform”, while raising his target price to $18 from $16. Silverstein now expects Nortel to make 49 cents a share in 2007 (compared with an earlier estimate of 37 cents) and $1.08 in 2008 (compared with 94 cents).
As much analysts and investors would like to believe the third-quarter performance is an indication that Nortel has finally turned the corner, the company still faces a number of major challenges.
Among them is the competitive landscape, which remains difficult as suppliers battle for business from carriers and cablecos who have adopted a pragmatic approach to new investments. Nortel’s rivals not only include players such as Cisco Systems Inc. and Alcatel-Lucent Inc. but low-cost rivals such as Huawei Technologies Co. Ltd.
On the conference call, Zafirovski declined to offer guidance for 2008 but he said that, “the environment is tougher”. This include soft prices in market such as wireless and optical.
In a recent research report, RBC Capital analyst Mark Sue said Nortel’s challenges include eroding a market share in GSM, and 4G taking longer than expected to ramp. “Nortel may see little topic line growth in its wireless segment in 2008,” he wrote, adding that the issue is being compounded by an ongoing restructuring at Sprint, a key customer.
While demand in the enterprise market is still healthy, Sue said Nortel must “reinvigorate its products as many as showing some signs of age”.
Meanwhile, UBS Securities analyst Nikos Theodospoulos had a mixed take on Nortel’s third-quarter results. While the numbers were good, Theodosopoulos said he didn’t see enough positive traction to change his view on the stock, which he rates as “neutral” with a price target of $20.
Among his biggest concerns looking into 2008 and beyond are the impact on Nortel of potentially flat to lower CDMA sales, which could hurt operating margins.
“Unless Nortel delivers meaningful operating margin expansion in Enterprise and Metro Ethernet, we see the company having a difficult time achieving its long term goal of double digit operating margins,” he said in a research report.
For its part, Nortel, which employs more than 2,000 people at its campus in Research Triangle Park, N.C., is buoyed by several initiatives and development. The goal to reduce operating expenses by $1.5-billion a year continues to be a major focus as the company strives to be more productive and do a better job on making sure that its research and development dollars are allocated to the right projects.
Zafirovski said 80% of R&D spending is now focused on new and emerging areas, including Wi-Max, which has emerged a key strategic initiative.
Zafirovski said Nortel believes it is well positioned in Wi-Max, although “time will tell over the next six to nine months”.
“It our biggest bet in terms of monetary amounts,” he said, adding “We think Wi-Max will be an explosive growth story for the industry in 2008, and we are fighting aggressively there.”
Another plank of Nortel’s growth strategy could be acquisitions. There was speculation it was interested in Avaya Inc. earlier this year before Avaya was purchased for $8.3-billion by private equity investors.
The latest rumors involved Tellabs Inc., which is seen as a good fit if Nortel wants to expand its enterprise business. While Zafirovski declined to comment on Tellabs, he told BusinessWeek that acquisitions could be part of the mix.
"We are looking at things across the board," he told BusinessWeek. "We’re always looking at complementary activities to help us bulk up."
If Tellabs is interesting to Nortel, the price has become more attractive since rumors initial surfaced in August. Since that time, Tellabs shares have nearly dropped in half giving a market capitalization of $3.4-billion.
