Is Nortel worth buying?
By MATHEW INGRAM
Globe and Mail Update
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Nortel (nt-t)
Another wave of bad news rolled over Nortel Networks earlier this week, just the latest in a seemingly never-ending stream of woe for the telecom equipment maker. The U.S. Attorney's office in Texas said that it is investigating Nortel's financial statements, joining a crowd that includes the U.S. Securities and Exchange Commission, the Ontario Securities Commission and the RCMP — and several major shareholders have launched legal claims against the company.
Could things get worse for Nortel? It's possible. Some or all of the investigations could result in fines or other sanctions, as similar cases have with other companies. At the same time, however, Nortel's actual business appears to be improving, as spending picks up in the wireless sector and in other areas such as voice-over-internet (VOIP) gear. That leaves investors impaled on the horns of a dilemma: buy the stock for the business, or sell it because of the legal question marks?
Perhaps the biggest problem for Nortel is a lack of trust. Investors don't know whether to trust the picture that they are getting of the company's financial health, given recent events. After all, many investors thought everything was coming up roses last year, when Nortel announced that it had turned a profit for the first half of the year and was paying its executives bonuses. Any investors who had either held on to their shares or bought some at $1 or $2 each were congratulating themselves as the stock hit $10.
Admittedly, some of that optimism evaporated when Nortel said it was restating its financial results for 2001, 2002 and part of 2003 — but investors were assured this was merely an accounting-related measure and not something to get concerned about. In fact, it wound up improving Nortel's bottom line. Then, Nortel said it was going to have to restate its results for those periods for a second time, and that's when all hell broke loose. Senior executives were placed on leave, and then they and CEO Frank Dunn were all fired. The SEC announced that it was investigating, and then the RCMP, then the OSC.
Now, the U.S. Attorney's office in Texas has handed Nortel a grand jury subpoena to turn over financial documents as part of a criminal investigation. Lawyers for the Ontario Public Service Employees Union (OPSEU) pension trust have filed a class-action lawsuit, as has the Ontario Teachers Pension Plan, a Dutch pension fund and the state of New Jersey's pension fund, alleging misrepresentation and pointing the finger at the bonuses Nortel officers received. The OSC has banned 160 insiders from trading the stock, and Nortel could be in default of certain debt agreements.
Not surprisingly, this storm of legal and regulatory inquiry has taken its toll on Nortel's stock. In March, the shares were still well over the $10 mark, up from about $6 in September and $4 in July. Now, they are right back where they were last year about this time — just north of $4, or down about 60 per cent in the last two months. In trading Tuesday, the stock slumped more than 5 per cent to hit a nine-month low of $4.16 on news of the class-action complaints and the OSC's trading ban.
Even as all that has been happening, however, Nortel's actual business has been improving. Telecom carriers seem to be increasing their spending on next-generation wireless and on voice over Internet technology, both areas in which Nortel is strong. The company has signed several major deals with carriers such as BellSouth and Verizon this year, although so has its main competitor Lucent — which, ironically, has also been investigated for filing misleading statements and was recently fined $25-million (U.S.) by the U.S. Attorney's office.
Gabriel Lowy of Blaylock & Partners, says he rates the stock a "buy," despite the legal and regulatory quicksand it is in, because Nortel's actual operations seem to be healthy. "It's not for the faint of heart but, so far, there's still no detectable evidence that customers are abandoning Nortel," he told Reuters. "Until there is evidence of that, I still think it's important to separate the accounting issues from the core underlying business."
Analyst Albert Lin of American Technology Research feels the same. "We are convinced the key aspects of customers, sales and cash are real," he said in a recent report. "We believe shares of Nortel are oversold." Goldman Sachs also said recently it continues to recommend Nortel despite "a significant amount of risk related to the overhanging accounting issues." The firm pointed out that Nortel's business had not been affected, and said profitability was "intact." Given all those factors, Goldman said the stock price was currently valued at a level that "discounts much of the risk."
At about the $4 (U.S.) level, Goldman said that Nortel was selling for about 1.4 times its projected revenue for 2005, and noted that even the latest financial restatements will not have any effect on the company's revenue, making that a good yardstick for value. Given the company's profit margins, Goldman says it should be trading closer to 2 times its revenue, which would imply a share price of $5.50 (or $7.65 Canadian).
No one is saying that Nortel's legal and regulatory woes are going away tomorrow, nor should they. But underneath all those issues - which will obviously take some time to sort out, and possibly involve some form of financial penalty — the company's business appears to be healthier than it has been for some time. For longer-term investors, that might be some comfort amid the storm.
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