Nortel investors enter a world of pain

To paraphrase John Goodman’s character from The Big LewbowskiNortel investors have just entered a world of pain. Their beloved company – the pillar of everything technological in Canada, the superstar of the networking equipment sector, the big fish of the Toronto Stock Exchange – has just fallen from its pedestal. Anyone who bought shares a month ago has lost 35 per cent of their investment, and those who got in last September have seen more than 75 per cent of their stake obliterated.

More important than just the stock-market losses, however ($260-billion and counting), is the loss of faith in Nortel’s ability to continue its remarkable growth – not to mention the loss of faith in the company’s ability to forecast. As everyone knows, stock prices rise and fall based not on current performance but on future potential, and investors aren’t likely to trust Nortel’s crystal ball gazing as much as they did a week or so ago. How long will it take for that trust to return? Good question.

Just three weeks ago, Nortel reassured the market that its business still looked strong – despite all the warnings from telecom equipment companies such as Lucent Technologies and even Cisco Systems. The company made a point of saying it still expected to increase its revenues and earnings by 30 per cent this year, projecting a profit of 16 cents a share in the first quarter and revenues of $8.3-billion. Now it says its revenues will be $6.3-billion or so, and it will lose 4 cents a share for the first quarter – and growth for 2001 will be more like 10 to 15 per cent.

The difference between those two forecasts is a massive, head-rattling change for a business the size of Nortel to undergo in just three weeks – the kind that should give a chief financial officer or a CEO whiplash. It’s certainly the kind of change that would make the most trusting investor wonder what the hell is going on over at Nortel HQ.

How could the business have gone sour so quickly, for the company to lose almost $2-billion in sales and 20 cents a share profit in three weeks? Either the company doesn’t know what is really going on in its industry – which is hard to imagine, given the obvious warning signs over the past months – or Nortel suffers from a massive case of hubris, believing it could somehow win while everyone else was losing. In the West, this is known as “drinking your own bathwater,” and it is bad news.

If you’re a retail investor who has a few bones to pick with John Roth about his ability to manage his business, you’d better get in line. The phones at Nortel probably started lighting up within moments of the announcement about slower growth, and the list of aggrieved investors and others is likely to be long. Up near the top would be JDS Uniphase, which just a week ago took $2-billion in Nortel stock in return for a plant in Zurich, Switzerland – those shares are now worth 35 per cent less.

Nortel’s bombshell announcement about slower growth has also torpedoed the share price of many other members of the telecom equipment sector, stocks that just finished getting a boost from a bullish report by optical equipment maker Ciena on Thursday. JDS Uniphase tanked by more than 20 per cent on Friday, as did fibre-optic maker Corning, which said its growth would be hurt by lower sales to a certain customer – a customer analysts said was likely to be Nortel itself. Even Ciena was down 8 per cent.

If you’re wondering who comes out of all this looking pretty good, look no farther than Sanford Bernstein analyst Paul Sagawa, the guy who was jumped on by many of his fellow Nortel-watchers when he came out with a negative report on the company and the entire sector in September, when Nortel was at $66 (U.S.). He looked smart when Nortel underperformed expectations in October, at which point the stock lost 25 per cent (and pushed the TSE down by over 800 points) and he looks even smarter now.

The financial wizards at BCE Inc. also look pretty good, seeing as how they locked in their profits on their remaining stake in Nortel when they spun the company off as a separate entity a year ago. They “hedged” the Nortel stake by striking a deal with a consortium of banks to guarantee BCE $90 a share on Nortel, regardless of what happened to the stock after the spinoff. In effect, the company has $2.8-billion more now than it would have if it had not hedged that Nortel stake. Let’s hope the banks sold those shares short at some point, or they are now stuck holding the bag.

As for the retail investors who believed Mr. Roth’s repeated reassurances that all was well at Nortel, they are now holding the bag as well, and they aren’t likely to cut the CEO much slack for the foreseeable future. Does Nortel still have good prospects? Yes – it’s still a leader in the optical equipment game, and it will continue to grow (although at a much slower rate). But investors are going to feel burned, and rightly so – and they will be twice as reluctant to believe any future rosy forecasts.

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