Nortel: Plan Z

Nortel files for bankruptcy protection in a desperate bid to survive.

Investors and other industry watchers of Nortel Networks Corp. (TSX: NT) will have lost track of how many Plan Bs the communications equipment manufacturer has churned through ever since the dot-com and telecom bubbles burst. But when the Toronto-based company reluctantly bit the bullet and filed for bankruptcy protection on Jan. 14, it was clear that this was its final, slim chance at saving itself from vanishing altogether. “Nortel must be put on a sound financial footing once and for all,” said president and CEO Mike Zafirovski in a statement.

Zafirovski, a veteran of GE and Motorola, parachuted in to lead the unprofitable company out of its morass of accounting scandals, financial restatements, operational disarray and misfired product strategies in November 2005. He made some progress in his three- to five-year turnaround plan. But not enough. Business was bad, and it wasn’t going to get any better in 2009.

The last-ditch effort comes amid declining sales, worsening economic conditions, more rounds of layoffs and looming interest payments on its US$4.5-billion debt. With US$2.4 billion in cash as of Jan. 14, Zafirovski could have tried to ride out the storm despite Nortel’s estimated US$100-million-a-month burn rate. Instead, he and the board of directors chose to face creditors sooner rather than later to preserve the liquidity Nortel has to fund operations — in other words, undertake a massive financial restructuring before it actually hits the wall.

However strategic, filing for creditor protection — under the Companies’ Creditors Arrangement Act in Canada, and under Chapter 11 of the U.S. Bankruptcy Code — is still a gamble. The stated plan is to emerge from the process with a better cost and debt structure. As Zafirovski was quoted in a company statement: “I am confident that the actions we’re announcing today will be the fastest, most effective means to translate our improved operational efficiency, double-digit productivity, focused R&D and technology leadership into long-term success.”

But there are a number of risks. Suppliers and customers, some of whom were already defecting, could be wary of doing business with a company under bankruptcy protection. As well, competitors like Cisco and Alcatel-Lucent will intensify efforts to steal market share. Nortel executives scrambled to assure key accounts that they intend to continue conducting business as usual. “There must be a bit of a sense of urgency to the bankruptcy protection proceedings,” says Lawrence Surtees, a vice-president at IDC Canada. “I’m sure Nortel would like to get at it as soon as possible, so that its customers know what they’re doing business with.”

Even if there are no further disruptions to operations — and that’s a big “if” — bankruptcy protection is no sure remedy. The company will have to come up with a plan of arrangement to present to the court and its creditors. The central questions will be what assets or business divisions Nortel is prepared to sell, at what price and, importantly, whether there are buyers. Given the global economic crisis, and the fact that Nortel has been unable to unload its Metro Ethernet Networking Solutions division at a good price since September, it is hard to estimate how much money the company can raise to appease creditors, whether any positive value will be left for shareholders (highly unlikely) — or whether Nortel will need to be completely liquidated. Only one thing is certain: Nortel’s strategy of competing in multiple communication equipment markets has now unequivocally failed.

Despite Zafirovski’s unflagging optimism, there are no assurances that Nortel, a Canadian technology success story that traces its roots to 1882, will be around in any form a year from now. “It’s almost impossible to tell,” says Duncan Stewart, president of DSAM Consulting in Toronto, a tech industry research firm. “It depends what prices it gets, how flexible the pension side is, how flexible the debtors are. It is certainly possible that a chunk of Nortel could emerge from this, restructured, properly financed, and be a completely legitimate technology player, but in a subset of what Nortel does today.” So the best-case scenario is that some greatly diminished piece of it remains. But Nortel’s track record of Plan Bs does not warrant hope.