The Globe & Mail: Nortel gets it - wrong
CROSSED SIGNALS
A mixed message has cost the telecom giant $9.1-billion
in capitalization in the span of a week. Company officials
prompted a mass stock selloff by issuing an off-hand
warning of slowing revenue growth
and then scrambling to clear up the confusion.
Saturday, October 3, 1998
SIMON TUCK and JANET McFARLAND
The Globe and Mail
in Ottawa and Toronto -- SIMON TUCK
in Ottawa
JANET McFARLAND
in Toronto
It was just a brief utterance made on the fly at the end of a prolonged
presentation on the state of Canada's largest high-tech company. But it
sent analysts grabbing for their cellphones and searching for a quiet
stretch of hallway as they frantically sold off Northern Telecom Ltd.
stock.
The now-infamous warning by Northern Telecom chief financial officer
Wes Scott about slowing sales growth, made at a meeting with analysts
Tuesday, had by yesterday wiped $9.1-billion off its market
capitalization, damaged the well-respected company's credibility,
sparked calls for the resignation of senior executives and even
heightened fears about its overall direction.
How could Northern Telecom fall so far, so fast?
The company's big foul-up, analysts say, was that it didn't come clean
sooner with projections of lower revenue growth in the third quarter,
and then appeared to be doing so almost as an afterthought at the
company's annual gathering on Wall Street this week. The warning was
all the more surprising because earlier the same day, Nortel had issued
a bullish report saying revenue looked strong.
"Northern Telecom is a big and brilliant company," said Duncan
Stewart, who manages the Navigator Canadian Technology Fund for
Tera Capital Corp. "[But] I have never seen a molehill turned into a
mountain by the inept handling of such a small situation. This was
handled about as badly as it could have been handled."
John Roth, chairman and chief executive officer of the Brampton,
Ont.-based company, conceded in an interview that the company
blundered, as officials thought the revised figures weren't such a big deal
because revenue forecasts -- not earnings -- were at issue. "This was
not a big event. But clearly the audience felt otherwise."
The message to analysts was delayed until this week, Mr. Roth added,
because European sales are always soft during the summer, so the
slowdown wasn't noticed until mid-September. The company still
expects a record third quarter, he said.
Still, the messy incident also raises questions about the selective access
analysts have to company information. Billions of dollars of shares
traded hands within minutes on Tuesday afternoon before anyone
outside the elite group of analysts knew what was going on.
"From the point of view of the individual investor, it is of concern
because you don't know what these meetings are about," said Bill
Mackenzie, vice-president of Fairvest Securities Corp. "They have
these insider meetings, and the little guy out there is not a party to it, and
finds out subsequently in the newspaper why the stock got battered."
If the first major effect of the foul-up turned out to be a rapidly
dropping stock price, the second could be the axe coming down on at
least one top Northern Telecom executive. Mr. Roth, investor relations
manager Bob Kaye, and especially Mr. Scott are considered by some
analysts as candidates to be shown the door.
Mr. Roth said yesterday the management team will remain intact. The
company's board of directors, however, could make changes.
While the matter has dominated Bay Street chatter for the better part of
a week, Northern Telecom's debacle affects much more than the
company itself.
The stock, worth more than 4 per cent of the Toronto Stock Exchange
300 index, is a favourite among small portfolio investors and mutual
fund managers. The only listing with a larger capitalization is BCE Inc.,
a holding company comprised of 42 per cent Northern Telecom stock.
Indeed, Northern Telecom shares had never been more popular than
this year, fresh on the heels of two consecutive years that saw the stock
rise more than 50 per cent.
The company's well-being also has a more direct effect on dozens of
other firms, particularly in Canada. As a well-heeled buyer of everything
from fibre optic components to office furniture, the high-tech giant
spearheads a sector reputed to be one of the Canadian economy's
engines of growth.
It's that strength and availability of resources that made this week's
warning so confusing. Senior executives made a rookie error that is
hard to understand, said Robert MacLellan, a technology analyst with
Kearns Capital Ltd. in Toronto. "It's got me scratching my head."
In fact, the fumble was so unusual that many analysts have been paying
more attention to the unorthodox delivery and the discrepancy between
the company's bullish early morning message and its end-of-the-day
warning than the numbers.
"It's a question of credibility," said Benoît Chotard, a technology analyst
with Lévesque, Beaubien, Geoffrion in Montreal.
Operating in a profession that ranks a lack of clarity as an almost
unpardonable sin, analysts say Northern Telecom committed a serious
breach. "We operate in a blue-sky environment," said Mr. Chotard,
with "true, plain disclosure."
The irony of the foul-up is that Northern Telecom's warning is a minor
downgrade of its revenue growth forecast -- from the "mid-teens" to the
"low double digits." (The company reports the exact third-quarter
numbers Oct. 17.)
"[The warning] was not that big a deal," said Mr. Stewart.
But it is now.
The firm has paid an incredible short-term penalty for the apparent
bungling. The stock opened Tuesday -- before the bungle -- at $61.70
on the TSE. Yesterday, it fell for the fourth consecutive day, closing at
$48.00
The fiasco will become a classic example of the danger of holding
private analyst meetings, corporate governance experts say.
By barring the media and interested smaller shareholders, Northern
Telecom created a situation in which analysts believed they had "hot"
new information that no one else possessed. As a result, they rushed to
the cellphones and the selling began as the rumour spread by word of
mouth.
"Really, everybody's a bit panicky about markets and earnings, and this
one hit home," said Mr. Mackenzie of Fairvest Securities, which
specializes in corporate governance issues. "Maybe [Northern
Telecom] set out with no intentions of disclosing anything that would be
considered privileged, but it was construed."
A 1996 report commissioned by the Toronto Stock Exchange focused
on problems of selective access, concluding that companies should take
precautions not to give insider information to analysts.
The report, authored by lawyer Thomas Allen, said analyst meetings are
here to stay, but should be opened to other investors and the media, at
least to listen to a tape recording afterward on a 1-800 phone line.
A 1995 survey of analysts conducted for the Allen committee found
that 62 per cent indicated they frequently obtain previously undisclosed
information through discussions with management -- a potential violation
of securities laws.
The committee said meetings with analysts are a "delicate dance" that
sees companies communicating somewhat obliquely to leave
impressions without clearly offering insider information and breaching
the law.
But Mr. Mackenzie said that "delicate dance" creates the perfect
climate for the kind of confusion that arose at Northern Telecom's
meeting, when analysts left with different interpretations about what was
said.
"A company like Northern Telecom is going to be careful about what it
says at that kind of a meeting, and the analysts are going to try to see
through what's being said," he said. "They're going to try to read
between the lines, to figure out, 'What are they saying here?' "
Corporate governance consultant J. Richard Finlay said it is not easy
for companies to be vague enough and still get across material new
information. He said analyst meetings raise crucial legal issues.
"It raises the questions as to whether or not people in a room having a
meeting like that become insiders, and whether they should be acting on
the information they receive," he said.
The next question facing Northern Telecom is: What will the disaster
mean in the longer term? Will the company be able to regain its
credibility and the support of the financial community, or will it be
lowered in status to "show-me" stock from blue-chip?
While it may be at least a year or so before that question can be
answered, what is clear is that the foul-up occurred at what may have
been the worst possible time. Events both within and outside the
company have converged in recent weeks and months to make the
company and its sector extremely vulnerable. In short, the conditions
were just right for a meltdown.
"This is the worst of all possible scenarios," said Mr. MacLellan.
Top officials are trying to stitch together a cumbersome merger with
Bay Networks Inc., a Santa Clara, Calif.-based firm Northern
Telecom purchased in June for $7.6-billion (U.S.). Despite Bay's status
as North America's second-largest seller of phone network equipment,
many analysts question the wisdom of the deal, saying the price was too
high and the two firms' corporate cultures were too disparate.
Some even say Northern Telecom, in a desperate bid to forge a leading
role in Web-based applications, bought the wrong firm. "Bay is still
trying to get its act together," said Mr. MacLellan, who is among those
that believe the deal was a mistake. "They should have bought Ascend
[Communications Inc.] and got the prime piece of real estate."
The deal already paved the way last month for 3,500 layoffs among
Northern Telecom's global work force of 80,000, a clear signal to
some that things were not going well. Speculation persists that as many
as another 3,500 job cuts are on the way.
No matter what some analysts may think about the deal, however, most
agree it had little or nothing to do with Tuesday's revenue warning.
Concerns about the deal may, however, have contributed to the
massive stock selloff that followed the warning. If there weren't serious
concerns about the deal, there may not have been so many
trigger-happy dealers anxious to downgrade Northern Telecom
recommendations.
There are also serious concerns that the entire telecommunications
industry may be cooling after a couple of years of staggering growth. In
addition to Northern Telecom's warning, Paris-based equipment maker
Alcatel SA saw its stock pounded after making a similar revelation in
early September. Northern Telecom's arch rival Lucent Technologies
Inc. of Murray Hill, N.J. also suffered a sharp share price drop this
week, even though the company is saying it will meet its fiscal targets.
The financial woes come at a time when voice networking firms are
racing to transform themselves into data networking firms as the two
worlds converge. Northern Telecom, which is betting on Internet
Protocol (IP) becoming the industry standard, calls its one-year-old
strategy Webtone.
Francis McInerney, principal of North River Ventures Inc., a
U.S.-based venture consultants firm for the telecommunications
industry, said the sector's biggest players are battling to provide what
customers want most, namely a seamless, all-in-one package that
includes television and the Internet.
"The two most powerful information galaxies, television and the Net,
are colliding . . . [and] the two have just slammed into each other."
Meanwhile, Mr. Roth and analysts agree it's unlikely the industry will be
able to sustain its staggering growth. Asian and European markets are
being blamed for most of the slowdown, but much of the world is facing
a possiblerecession and telephone companies are being viewed as less
likely to be in the mood for major investments.
For investors, the mix of problems -- the company, the industry and the
global economy -- is a nasty brew. With high growth expectations
already factored into share prices, technology stocks are highly volatile
and don't need much more than a twitch to trigger a free fall. In fact,
Northern Telecom shares had already plunged almost 20 per cent in the
three weeks prior to the New York session.
Analysts and investors are now wondering when the
telecommunications giants -- Northern Telecom in particular -- will
return to their glory, if ever.
Some say the whole issue has been overblown. Northern Telecom
officials messed up their analysts' session by not being up-front, said
Gurinder Parhar, a technology analyst with HSBC Securities in
Toronto, but it's not the end of the company. "They should have done a
better job with the presentation, but . . . nothing ever works out
perfectly. I am sure the company will recover."
However, others say the company itself, not just its stock or its market
position, has taken a big hit in the last week.
"They've lost the confidence of the Street, both bulls and bears alike,"
Mr. MacLellan said. "It's going to take a long time for the company to
recover what they've lost in the last few days."
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