Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Technology Stocks : Nortel Networks (NT) -- Ignore unavailable to you. Want to Upgrade?

To: Ian@SI who wrote (13812)	4/29/2004 11:05:45 AM
From: Stock Farmer	Read Replies (3) \| Respond to of 14638

Speculate is all we can do. But from the little they've told us, not difficult to piece together a plausible scenario. What if senior management was aggressive in estimating anticipated losses during 2001/2002 timeframe? It wouldn't be the first company in trouble to take such a course - better to over-estimate expected losses when folks think you are going to lose rather than lose later when they think you're going to win. That was in the past. The dust has settled. The company is back on an even keel. But now it finds itself having more "expected" losses on the books than they are actually going to incur. Which also usually happens. So there is an extra intangible asset on the books that has to be made to go away. There are two ways this can be done. The first is to write it all off as a lump sum. The second is to restate prior periods using the benefit of hindsight to reduce the provision for "expected" losses to what might have been more reasonable expectations so that there's less (or no) excess to write off now. The typical approach is to write off the excess provision and go forwards. Happens all the time. But what if, hypothetically, the magnitude of this writedown is larger than their profits? Then the company would report a loss in the year immediately after returning to profitability. Ooops! The market response would be brutal and punishing. NT must stay in the black. So a restatement is necessary. But rules prevent companies from reaching back in time and adjusting prior period reports at whim. They need a good reason. And I expect that in looking for such a reason they discovered evidence of management intentionally salting away excess losses, with the knowledge and at least tacit agreement from the top. Presto, a reason to restate results. Meanwhile, back at the board, they aren't happy campers. Management is facing them with a no-win situation. Either declare a loss for the year after having already declared a sustainable return to black, and be trashed by the financial markets, or restate the results of prior years. And be trashed by the financial markets. All because of inadequate financial controls. Which is all about asking the question "how come we didn't report this in Q1?", to which the answer of "then we wouldn't have earned our multi-million dollar return to profitability bonuses" is entirely unsatisfactory. The irony of this is that the underlying causal chain is actually more positive than negative: the company didn't lose as much as we all thought it did. However, it all goes to management competency, and this is why, we can assume, Dunn was fired for cause. Top management's entire responsibility is for establishing effective controls and control processes. When the CEO happens to also have been the former CFO, there's no possibility for him to duck from lousy management controls in the area of financial accountability. Do we have cause to doubt the company? To some extent, yes. It's not that the restatement of the loss provisions themselves are bad news, but the implications that with loose controls we have reduced confidence that other more significant issues are lurking. Personally, I suspect a buying opportunity here. Buyer beware.