If you do not like Sagawa, if you do not like Reuters, avoid the following:
Thursday March 22 1:48 PM ET
Nortel Now Faces a Delicate Balancing Act
By Susan Taylor
OTTAWA (Reuters) - After a year of gorging on growth, Nortel Networks Corp. (Toronto:NT.TO - news) (NYSE:NT - news), the world's biggest telecom equipment supplier, must now go on a crash diet that analysts say must be strict but not sacrifice flexibility.
Nortel must abandon its all-out expansion efforts as the fiber-optic spending boom of 2000 is replaced by telecom spending cuts and an increasingly fragile global economy.
But the company must not cut back so deeply that it can't quickly recover when demand does rebound, analysts said.
``I think that Nortel is guilty of hubris and guilty of being insufficiently cautious and paranoid,'' said Sanford Bernstein's Paul Sagawa, the first analyst to downgrade Nortel last September amid signs of a demand slowdown.
``They moved ahead with this sort of single-minded vision (that) if they could just tool up capacity, they could win. And I think that that's turned out not to be the case.''
Add to that mix a shock earnings warning that sparked a hornets nest of class action lawsuits, skeptical analysts waiting for further estimate reductions, and cost cutting measures that will axe 10 percent of all jobs.
Staff are now being told to pinch pennies in the hope they land on the bottom line. Employees must now brown-bag meals for meetings, book the cheapest flights they can find and cancel newspaper subscriptions.
It didn't help matters when a recent regulatory filing showed that chief executive John Roth pocketed $100 million last year, including $88 million in stock options, a bonus of $5.6 million, and a salary of more than $1 million.
Still, Nortel must carefully wield its cost-cutting knife and protect product development, said David Heger, an analyst at AG Edwards & Sons.
``They have to be cautious about not going too crazy after the R&D budget,'' he said. ``They don't want to drop the ball on that leadership.''
Overhaul Required
What's needed at Nortel, which transformed itself from ''stodgy'', steady expansion to hyper-growth, is a major overhaul to adjust to the sector's a cyclical sales, Sagawa said.
Cyclical sectors, such as the semiconductor industry, churn through regular periods of high demand followed by oversupply.
To accommodate that pattern, Nortel needs to adopt more flexible staffing and manufacturing plans, invest in counter-cyclical companies and set longer-term financial targets ``that are more realistic,'' Sagawa said.
Nortel has been widely criticized by Wall Street for its earnings cut in February, which has been called too cautious and confusing. While first-quarter estimates were cut by 20 cents, the full-year forecast was trimmed by only 18 cents.
On average, analysts expect earnings of 64 cents a share in 2001 -- 16 cents below the company's forecast.
``My guess is what ends up happening is the company comes out with a press release at some point saying they're comfortable with the First Call band of estimates -- and it's so wide it tells you nothing,'' said Salomon Smith Barney analyst Alex Henderson.
While such a move would avoid a formal earnings warning, it would likely knock further value from Nortel's battered stock, which, at around C$25.80 on the Toronto Stock Exchange and $16.50 in New York, is about 80 percent off its year high.
``It's such a negative environment everybody believes in the cockroach theory right now: if you see one (warning) you're going to see more,'' said Wachovia Securities analyst George Hunt.
Rebound Tough To Call
Nortel's toughest task may be predicting the timing of a recovery and preparing for it.
``We're not going to make any forecasts,'' Roth told Reuters one day after the company issued its warning. ``I defy anyone, really, to predict what's going to happen in the U.S. for the next three to four, maybe six months.''
UBS Warburg has cut its 2001 growth target for the telecommunications equipment sector to 9 percent from 10 to 15 percent and said the market may not recover to traditional rates of 15 to 25 percent growth until 2003.
While Nortel's current woes stem largely from a slowdown in the U.S. market, where it records 60 percent of its sales, there are signs the bad news is crossing borders.
Cracks have appeared in Europe, which Nortel has said would continue to grow, along with the Asian-Pacific region, despite North America's decline. Analysts say Nortel has recently lost European deals with British Telecom, 360networks Inc., and Verizon to competitors' cheaper bids.
``From a shareholders' perspective, there will be much more bad news coming across the table rather than good,'' Sagawa said.
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