Nortel shortfall: Moment of truth for investors

When Nortel Networks said it would badly miss its earnings projections Feb. 15, Alexander L. Muromcew didn’t see any light at the end of the tunnel.

The announcement, one in a string signaling disappointing earnings by some of the biggest names in the industry, created yet another moment of truth for investors, financial advisers and money managers.

Is it time to hold or fold on another battered leader of the tech revolution?

dumping shares

For Mr. Muromcew, the San Francisco-based portfolio manager for Loomis Sayles & Co. the answer is fold.

Since the fourth quarter of last year, he has been dumping shares of the Brampton, Ontario-based telecom equipment maker from the mutual funds and private accounts he manages.

“We no longer hold the stock, because this [downturn] isn’t a one-quarter phenomenon,” he says. “It’s a 12-month phenomenon.”

Mr. Muromcew says he believes the tech sector’s cyclical downturn is the worst since the one in 1985 and 1986 and that Nortel, a stock with its own issues, is ill-positioned to buck the trends.

But faced with the same grim circumstances, John B. Sullivan, principal with Portland (Maine) Global Advisors, has decided to hold on to his portfolios’ Nortel positions.

After Nortel CEO John Roth admitted to grossly overestimating revenue during the company’s latest conference call, Mr. Sullivan was pessimistic about the stock’s short-term prospects. But he believes Nortel’s management will regain its magic touch.

He remembers 1998, when Nortel shares plunged after an earnings surprise, and it paid off for investors to hold tight to the shares.

To hold or not to hold Nortel is a huge decision on the minds of asset managers in North America.

big stakes

The Fidelity Select Technology Fund had almost 6% of its assets invested in Nortel in August, and its counterpart, T. Rowe Price Science and Technology Fund, had a 3.11% position at the end of September, according to the latest data available from Morningstar Inc., the Chicago fund tracker.

But because Nortel is also considered a blue-chip share, it also made up 3.14% of the Aim Value A Fund and 3.27 percent of the Vanguard U.S. Growth Fund.

Reflective of its dual nature as a high flier and a safe flier, its crumbling revenues defy easy analysis.

Because of its large size, Nortel could not duck telecom carriers that are throttling way back on spending during the current economic slowdown. That means any upswing in the economy could dramatically improve Nortel’s results.

But analysts and competitors also note that Nortel has taken several wrong turns in technology and market strategy that – until now – were covered up by exceptionally strong sales of one or two optical networking products.

Cisco Systems Inc. CEO John T. Chambers was among the first to make that point in a November InvestmentNews interview.

“I think they’ve stumbled a fair amount both in terms of the results, but more importantly in terms of strategy,” Mr. Chambers said. “Nortel’s comments today remind me of Lucent’s comments 18 months ago – how they are hyping their growth [and] focusing on too narrow a segment of the market.”

Jack Harrington, a general partner with Advanced Technology Ventures in Palo Alto, Calif., says Nortel’s troubles are split between macroeconomic forces and microeconomic causes.

“You’re talking about a big company that has a big denominator, all other things [being] equal,” he says. “Ciena and Sycamore [two telecommunications competitors] can continue to look good from a growth standpoint because they have a smaller denominator.

“But I do think the Cienas and Sycamores of the world have woken up to the fact that software is pretty important in all this.”

Better mousetrap

Mr. Harrington is alluding to the much-noticed fact that Ciena Corp. in Linthicum, Md., came out with better-than-anticipated results at the same time that Nortel suggested economic conditions are highly unfavorable in the telecom sector.

Ciena’s stock shot up 16% to $89 on the heels of that announcement, but by Friday it had receded to $74.50. Nortel’s stock closed at $19.38 on Friday, down 35% since the announcement.

Ciena’s strong card is a sophisticated, software-based optical networking product called MultiWave CoreDirector that, experts say, makes Nortel’s products look old-fashioned.

“Ciena is going to be kicking everyone’s [butt] with this CoreDirector,” says Mark Lutkowitz, an optical networking analyst with Communications Industry Researchers Inc. in Charlottesville, Va.

One CoreDirector box replaces the 256 Nortel boxes necessary to carry out the same switching functions.

The smaller unit cost about 50% less, and the cost to run it is far less, Ciena officials assert.

Andy McCormick, senior analyst for optical communications for Aberdeen Group Inc. in Boston, says that another aspect of Ciena’s and Sycamore Networks Inc.’s products may offer a graver threat to Nortel.

Nortel products work only with other Nortel products, and customers want interoperability.

“If Nortel doesn’t innovate at the pace of another company,” he says, “you’re out of luck.”