Editor’s note: This is the first of a three-part series about where troubled telecom gear-maker Nortel stands in its recovery efforts 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 — Nortel (NYSE: NT) reports its latest quarterly earnings on Friday, and the news isn’t expected to be good.

Analysts are predicting a 3-cents-per-share loss on revenues of $2.5 billion. If so, the loss would be better than the second quarter in 2007, when the telecommunications gear maker lost 7 cents a share. However, revenues were also higher – $2.56 billion.

For investors who own Nortel, the first half of the year has been like riding a roller coaster.

After starting the year at just over $15, Nortel shares went into a sharp dive. By the middle of March, the stock had lost nearly two-third its value in plummeting to a record-low of $5.73 (57 cents before a 10:1 stock consolidation is taken into account).

Shares traded July 25 at $7.20 – about a third of the 52-week high of $22.97.

Nortel’s first-quarter results, while improved, where far from impressive as the company posted a $138 million loss, including an $88 million charge.

June news sparked a stock rebound

Nevertheless, Nortel Chief Executive Mike Zafirovski – Mr. Z as he’s called inside Nortel – kept preaching that the turnaround was making progress and that Nortel was slowly but surely on its way to becoming a “great” company again.

Mr. Z took over the firm in November 2005. He has put in place an almost entirely new management team, reorganized the company, shut down some operations and moved jobs to lower-cost countries such as Turkey.

However, his positive message did not manage to resonate with many investors until Nortel’s annual analyst day in early June, when Nortel caught everyone’s attention with several announcements:

  • It confirmed its 2008 outlook, including the forecast low-single-digit revenue increase and gross margins of 43 percent.
  • For all intents and purposes, Nortel got out of the Wi-Max business by announcing a strategic joint venture with Israel’s Alavarion Ltd., which will see Alvarion sell Wi-Max equipment for Nortel. Meanwhile, Nortel will focus its R&D efforts on LTE.
  • Nortel won a contract from Verizon Telecom to provide a new generation of switching equipment to help Verizon expand its metro Ethernet backbone.

The announcements pushed up Nortel shares by more than 30 percent to $10.21 – the highest level in nearly three months.

As important, they convinced some analysts that Nortel was, indeed, on its way back after several years of tough times, including an accounting scandal that jumped back into the spotlight when the Royal Canadian Mounted Police laid charges against ex-CEO Frank Dunn, ex-chief financial officer Doug Beatty and ex-controller Michael Gollogly after a four-year investigation.

Positive analysts’ views

Chris Umiastowski, an analyst with TD Securities, said Nortel’s investor day convinced him that the company had gone through a “massive cultural shift.”

“We walked away with more confidence in the management team, and we heard a lot of detailed information that backs up management’s plan to dramatically boost operating margin.”

“Aside from all of the details and plans presented by the company, we think that the most important takeaway is the overwhelming cultural change driven by Nortel’s new management team. 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,” Umiastowski said.

Another analyst enthusiastic on Nortel is Paradigm Capital’s Barry Richards, who published an ultra-bullish report a week before Nortel’s annual analyst day. In initiating coverage on Nortel, he rated Nortel as a “buy” with a one-year target price of $23. Even more astounding is Richards’ belief that Nortel will hit $50 a share in the long-term.

“We believe Nortel’s turnaround is complete, and we look for the stock to reverse its recent downward slide. Key catalysts could include improved quarterly financials, large contract wins, acquisitions and positive industry-related developments,” Richards said in the report. “The main risks could include regaining investor credibility, competition, managing technology cycles, the class-action share distribution, a U.S. recession, further restructuring costs and lumpy order flow. "

J.P. Morgan’s Ehud Gelblum also jumped on the bandwagon, upgrading Nortel to “overweight” from “neutral” – the first the investment firm has not rated Nortel “neutral” in four years.

Gelblum said Nortel will have better operating margins and better sales during the second half of the year. He said Nortel should have operating margins of 10 percent over the next one to two years due to lower expenses and its Wi-Max partnership with Alavarion. As well, he believes Nortel’s Metro Ethernet unit will see better profitability as sales of a new networking product climbs during Q3 and Q4.

In terms of the outlook for Nortel’s finances, analysts expect the company to post a loss of 3 cents a share based on revenue of $2.49 billion.

For 2008, Nortel is expected to post a profit of 58 cents a share on revenue of $11.2 billion, while the forecast for 2009 is a profit of 93 shares on revenue of $11.6 billion.

Part Two: Mike Zafirovski and his NT challenge