Nortel's bankruptcy: A long time coming

Question is: Can 4G wireless, enterprise gear bring it back from Chapter 11?

Nortel's demise -- punctuated by this week's bankruptcy protection filings -- started long before the accounting scandal of 2004 and the multimillion dollar quarterly losses that the company has piled up since.

Nortel's demise -- punctuated by this week's bankruptcy protection filings --  started long before the accounting scandal of 2004 and the multimillion dollar quarterly losses that the company has piled up since.

Nortel began unraveling after failing to capitalize on the huge acquisitions it made in the late 1990s and early 2000s. It paid $15 billion for two companies back then -- switch makers Bay Networks and Alteon WebSystems -- in an effort to transform itself from a century-old voice telephony stalwart into an IP voice and data powerhouse. But the acquisitions -- $7 billion for Alteon alone, which at that time had annual revenue just shy of $200 million -- came amidst the dot-com bubble. Navigating that while trying to establish itself in new markets like IP routing, and LAN and Web switching did not allow the company to grow or take substantial share in those markets.

Read about Nortel's relationship with Microsoft. 

This inability, coupled with declining revenue in its legacy voice business and the accounting scandal, steered Nortel irrevocably off-course this decade even as IP leader Cisco deftly managed and made the most of its multibillion dollar acquisitions. A deep-rooted complacency at Nortel didn't help matters either.

"As an incumbent telco equipment maker, Nortel was way too slow to embrace the reality of the change in the market that they served," says Thomas Nolle, president of consultancy CIMI Corp. "They should have been the No. 1 provider of routers to telcos. Hubris . . . prevented them from strategically absorbing Bay even though they financially absorbed them." ( Dell'Oro lumps Nortel into the "other" category in the telco router market, which has a 4% share of the $2.2 billion pie in the third quarter, well behind leaders such as Cisco and Juniper).

Nortel plodded along for years with stagnant or declining growth in IP routing and Layers 2, 3 and 4-7 switching, compiling just a 3.8% share of the $18 billion market in 2007. Meanwhile, the fraud forced the company to restate years of financial results, a situation inherited by CEO Mike Zafirovski when he took the Nortel reins in 2005.

But Zafirovski's efforts to restructure Nortel and get it back on track by focusing on 4G wireless, unified communications for enterprises, Carrier Ethernet and services have been largely fruitless -- culminating in last week's bankruptcy protection filings. Two days before the filing, Nortel unveiled a new line of stackable Gigabit Ethernet switches.

Some watchers believe Nortel assets in its Carrier, Ethernet Solutions and Metro Ethernet operations, which went on the block in September, will be sold off and its share in key markets dispersed among competitors. Others say Nortel may emerge focused solely on the enterprise and services, leveraging its strength in VoIP and alliance with Microsoft for unified communications.

Timeline of Nortel's fall

The entire unified communications market for the third quarter of 2008 was $3.1 billion, according to Dell’Oro. Avaya led the pack with 22% of that market followed by Cisco with 18%, then Nortel with 11%.

Nortel is also third behind Avaya and Siemens in share of the $4.8 billion market for hybrid IP/TDM PBXs in 2007, according to Dell'Oro. The company is also gaining share in enterprise voice applications, according to the firm.

But whatever the future holds, last week's filing was an attempt to put the brakes on the company's financial free fall.

A year ago, Nortel had a net profit of $27 million in the third quarter, but the company posted a net loss of $3.4 million in the most recent third quarter, which ended Sept. 30, 2008. Between the same periods, revenues dropped 14%.

The company's market value, peaking at $250 billion in 2000, is now close to 0.1% of that at $275 million. Sales of its stock were halted last week on the New York Stock Exchange, with its price at Wednesday's closing just 32 cents per share. The company is under a NYSE warning that it will be delisted in six months if the price doesn't rise above $1.

Legal filings to protect the company from its creditors came one day before it had to pay a $107 million bond payment.

The company says the bankruptcy filings reflect that it will take even more drastic measures to turn things around in this economic environment than the $400 million cost-cutting campaign it outlined in November that called for selling its metro Ethernet division, laying off 1,300 employees and shuttering facilities. Nortel has been unable so far to find a buyer for the metro Ethernet division.

Filing for Chapter 11 bankruptcy protection in the United States will allow the company to reorganize and undertake a comprehensive business and financial restructuring, says Zafirovski.

"I firmly believe these are the right steps toward a solution for our company," he says in a public letter addressed to Friends of Nortel. Despite its financial troubles, the company says in a press release that it will continue its day-to-day business as usual.

But filing for bankruptcy protection -- which can result in creditors receiving less than they are owed -- could influence decisions by suppliers and distributors about how to conduct business with the company. Already, competitors such as Enterasys, Extreme Networks and Juniper are swooping in to woo customers and channel partners.

Enterasys says it is offering Nortel and other competitors' customers a 100% credit on their equipment. HP ProCurve has no Nortel-specific enticement; rather, customers and resellers are coming to them, says Vice President and General Manager Karl Soderlund.

Some customers are remaining steadfast in support of Nortel, at least for the short term. The International Nortel Networks Users Association (INNUA) issued a statement saying it backed Nortel's decision and believes it will result in a stronger enterprise focus.

But it was still a sobering event.

"We've all read the media on what's been going on but it's always surprising, even when you anticipate that something's coming, that it actually does happen," said Steve Ford, president of INNUA. "But I think they'll emerge from this doing fine," Ford added, citing a discussion he had just had with Nortel Enterprise Solutions President Joel Hackney.

The company does have $2.4 billion in cash with which to weather the storm. But what it looks like after Chapter 11 is now ripe for speculation.

Bankruptcy courts could order the sell-off of other Nortel divisions. These include an enterprise division that includes network infrastructure, VoIP gear and contact center gear, and its core telecom division that sells to carriers.

"I don't think Nortel will go out of business," says industry analyst Jeff Kagan. "If things get that bad they would sell the company to a competitor first . . . if they can."

Copyright © 2009 IDG Communications, Inc.

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