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Nortel refines its strategy

The perennially beleaguered Nortel ( TSX:NT) held a conference in Toronto today for analysts and major investors ( webcast, with presentation slides). It’s all spin to some degree, but Nortel executives have earned a reputation for being pretty forthright about its businesspartly trying to still make up for previous leadership teams’ gross indiscretionsand it is a complex and fast-changing company that the market still views with truckloads of skepticism.
Since joining in 2005, CEO Mike Zafirovski and his hand-picked team have largely cleaned up the messes left behind by predecessor regimes under CEOs John Roth, Frank Dunn, and Bill Owens. So Nortel is no longer dysfunctional and implodinghooray! But there are lots of questions about the competitive strength of its diverse product portfolio for growth, and how it intends to become more profitable. (As of Tuesday’s close, its stock was off 74% since Zafirovski joined November 15, 2005, and down 46% year-to-date. Makes for an ugly chart). Today was focused on clarifying those matters.
Off the top, Nortel had two pieces of real news. The first was that it reaffirmed its outlook for 2008: Revenue will grow in the “low single digits” from US$10.95 billion in 2007, when they were up 2%; gross margin is on roughly on target for 43% of revenue (2007 was 42.1%); and operating margin, as a percentage of revenue, will increase 300 basis points to about 6.7% from 3.7% of revenue in 2007, and halfway to Zafirovski’s stated target of about 13%. So financially, things seem to be generally improving, albeit slowly.
The second newsis more intriguing: it’s partneringwith Alvarion, an Israeli company that is a leader in WiMax wireless broadband equipment, in a joint venture for both product development and sales. Investors certainly responded positively: the stock shot up more than 13% today, as of 3:30 p.m.).
As Nortel’s president of Carrier Networks division Richard Lowe explained during the conference, the deal will allow him to “meter my investment in WiMax,” and shift resources toward “the nascent technology” known as Long Term Evolution. More commonly referred to as LTE, the fourth-generation mobile wireless technology actually competes in some ways with WiMax, but Nortel sees the market emerging faster than anticipated: only a US$400-million market in 2010, according to Lowe, but quickly turning into US$1.6 billion in 2011, and a US$10 billion in 2015. As a couple of analysts from the conference floor pointed out, Nortel needs to convert its 30% market share in the second-generation (and in some ways second-rate) CDMA wireless standard into LTE customers, which is no given, and 2015 is a long time to wait for results.
Of course, it wasn’t that long ago that WiMax was touted as one of Nortel’s keys to growth. This deal suggests Nortel didn’t have all the pieces to really compete. As Zafirovski said, “WiMax…did not provide the revenues at the level we were expecting.”
Partnerships have become a big theme at Nortel. Chief strategist George Riedel noted that Nortel is not going to be successful in all of its many markets (some would say too many) by just going it alone, and certainly not profitably. Lowe claimed Nortel’s joint venture with LG Electronics of South Korea is performing well, and Joel Hackney, president of the Enterprise division talked up 800-plus customer wins from its Unified Communications partnership with Microsoft, and likewise some of its relationships with IBM and Dell. But so far, the partnerships have had minimal impact to the top and bottom lines.
Nortel is still selling mostly to telecom carriers, with more than half of its revenue (if you include related services) coming from its Carrier division, and a big chunk of that is based on CDMA, a second-generation wireless standard that is on the wane (some think it might tip off a cliff). Zafirovski is pinning Nortel’s growth on Enterprise and Metro Ethernet Networks divisions12% and 10% compound annualized growth rates between 2007 and 2011and operating margin projections are also aggressive. These two areas will have to make up for declining revenue in wireless, and shrinking operating margins in the Carrier division overall.
Watching how Nortel manages that transition will be fascinating. The company’s trying to ride out many swift changes in the communications marketplace, by becoming less of a pure telecom equipment business, and compete more directly with the likes of Cisco Systems (it has a new marketing push on how much more efficientits gear is, for instance). That means shifting its product portfolio into growth areas, and completely reinventing its corporate persona, while building on some of its old strengths in telecom. Riedel’s presentation pegged the telecom market at about US$300 billion, and the IT market at US$860 billion; converge the two and you have a market opportunity of more than a trillion dollars. Whether Nortel can position itself correctly in that market is what investors are waiting to see.
(This first appeared as a column on June 11: https://www.canadianbusiness.com/columnists/andrew_wahl/article.jsp?content=20080611_171027_3120)