Despite Reports, Nortel Operates as Usual

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Rich Tehrani
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Despite Reports, Nortel Operates as Usual

Reports are circulating that Nortel has declared bankruptcy and pieces will be sold off to foreign firms. Company sources say this is untrue. Here is the complete story.

In the past 24 months, global financial markets have gone from encouraging companies and individuals to take on as much debt as they can to abruptly stopping all financing and debt renegotiation. During the dotcom/telecom bubble, VCs poured money into companies, forced them to spend it rapidly and then evaporated, leaving the companies dead on the vine. Similarly, one day we all woke up and found out debt was bad and if we have it, we are in trouble.

How did Nortel get into this situation?

Remember the heady dotcom days when people made a year's worth of mortgage payments on a week's worth of optical stock gains. This is when Nortel was acquiring companies. They certainly weren't alone but when they should have been recovering from this overvaluation feast a few years later, CEO Frank Dunn and other corporate executives who were compensated by increasing stock valuation cooked the books.

The company has struggled since and depending on what numbers you want to use - taking into account leases, etc they have up to six billion dollars of debt which means they pay hundreds of millions of dollars of interest. Couple this with pension liabilities of a company which is over 100 years old and add a dash of really tough economy, tough Asian competitors and an aversion to marketing and you have an extreme challenge in front of you. Call it a business Rubik's Cube but with 100 squares on each of six sides.

All of these problems coupled with bad earnings and reports Nortel was consulting with bankruptcy firms started a firestorm of discussion online and the business media about Nortel's fate.

With an interest payment of $107 million due soon the company took the opportunity to reorganize their global enterprise in a manner in which they will likely retain control over the process.

I should mention that the nuances of bankruptcy code are not my area of expertise but given the direction of the global markets I do fully expect to be well-versed on the topic by the end of this year. In Nortel's case, as a multinational company they have to deal with different terms and codes in various countries.

In researching this post I spent a good deal of time reading about US and Canadian bankruptcy law, articles from trustworthy sources, a news release with a quote from the Canadian ministry of Industry, a voluminous statement from the company  and I spent a good deal of time picking the brain of the President of the Enterprise Solutions Division of Joel Hackney.

In the company's statement they mentioned they are seeking creditor protection under the companies' Creditors Arrangement Act ("CCAA") in Canada. They further explain certain of the company's U.S. subsidiaries, including Nortel Networks Inc. and Nortel Networks Capital Corporation, have filed voluntary petitions in the United States under Chapter 11 of the U.S. Bankruptcy Code, and certain of the Company's EMEA subsidiaries are expected to make consequential filings in Europe. The statement further explains the company's normal day-to-day operations are expected to continue without interruption. Another important statement is Nortel remains 100% focused on serving customers worldwide through continued R&D investments and support of its product portfolio to fulfill customer needs.

Since Nortel is a Canadian company it is worth looking at what experts like PwC say about the CCAA. According to the company, financially troubled companies owing creditors in excess of $5 million are eligible for court assistance in restructuring their affairs.

The following are the details according to PwC:

The process begins in the Court system when the company applies to the Court for protection under the CCAA. The Court will issue an Order giving the company 30 days of protection (often referred to as the "Stay") from its creditors to allow for the preparation of the Plan of Arrangement. The Court can extend the Stay against the creditors upon further application to the Court by the company. Typically, the Court will continue the protection beyond the initial 30-day period if the company can demonstrate that it is likely that it will file a Plan of Arrangement and an extension of the Stay is not prejudicial to the creditors, as a whole. There is no time limit on how long the Stay can be extended. During the Stay period, the company will often continue operating, although it may commence restructuring activities at any time.

A Monitor is an independent third party who is appointed by the Court to monitor the company's ongoing operations and assist with the filing and voting on the Plan of Arrangement. It is not uncommon to see a company's auditors acting as the Monitor. The Monitor's duties include monitoring the business, reporting to the Court on any major events that might impact the viability of the company, assisting the company in the preparation of the Plan of Arrangement, notifying the creditors (and shareholders) of any meetings and tabulating the votes at these meetings. The Monitor prepares a report on the Plan of Arrangement that is usually included in the mailing of the Plan.

The Plan of Arrangement is the proposal that the company is presenting to its creditors on how it intends to deal with debt it owes at the time of the initial filing with the Court. There are no restrictions on what the Plan can entail. It is not uncommon to see offers to pay a percentage on the dollar of debt, either as a lump sum or over a period of time. Plans can include an offer of shares of the company in exchange for the debt outstanding or a combination of cash and shares. The debtor can identify a particular creditor or group of creditors as "unaffected." Unaffected creditors are included in the Plan and are not to be paid in the normal course. One of the benefits of the CCAA is that it allows for this flexibility when trying to put together a Plan.

In order to be able to vote on the Plan and receive any distribution under it, a creditor must file a Proof of Claim with the Monitor. The Proof of Claim sets out what is owed to the creditor and is reviewed by the Monitor and the company. Any discrepancies between the creditor's Proof of Claim and the company's records are investigated by the company. The Plan will outline the procedures for dealing with disputed claims.

Ultimately, the company files its Plan of Arrangement and forwards it to the creditors/shareholders. A meeting of the creditors (and shareholders, if applicable) is called to vote on the Plan. For the Plan to be binding on each class of creditors, a majority of the proven creditors in that class, by number, together with 2/3 of the proven creditors in that class, by dollar value, must approve of the Plan presented to them. If a class of creditors approves the Plan, it is binding on all creditors within the class, subject to the Court's approval of the Plan. If all of the classes of creditors (and shareholders, if applicable) approve the Plan, the Court must then approve the Plan as a final step. Upon Court approval, the company continues forward as outlined under the Plan until it has satisfied the requirements under the Plan.

If a class of creditors or the Court does not approve the Plan, the company does not automatically go into bankruptcy, but the Stay is lifted. However, once the Stay has been lifted, the pressures that caused the company to initially file for CCAA protection from its creditors will likely return and, accordingly, it is quite likely that the company will be placed into receivership or bankruptcy.

US bankruptcy law is similar (at least to me) and if you have morbid curiosity, knock yourself out.

Nortel CEO Mike Zafirovski said in a prepared statement, "These actions are imperative so that Nortel can build on its core strengths and become the highly focused and financially sound leader in the communications industry that its people, technology and customer relationships show it ought to be. I am confident that the actions we're announcing today will be the fastest, most effective means to translate our improved operational efficiency, double-digit productivity, focused R&D and technology leadership into long-term success. I want to reaffirm Nortel's dedication to delivering world-class solutions and services to customers."

It is also worth mentioning the company's affiliates in Asia, including LG Nortel and in the Caribbean and Latin America, as well as the Nortel Government Solutions business, are not included in these proceedings and are expected to continue to operate normally.

Nortel is a huge Canadian employer and a tremendous source of pride for Canada. One would expect the Canadian courts to look to Nortel as favorably as possible.

In my conversation with Hackney he confirmed that a number of acquisitions at premiums contributed to the company's woes. Moreover, he reiterated the prepared statement that the company has 2.4 mbillion dollars of cash on hand.

According to Hackney, "Nortel is still very much in business." He went on to say they continue to be 100% focused on driving results for their customers. To understand why I can say this confidentially, you have to understand some of the details according to Hackney. He mentioned they announced a comprehensive financial restructuring of the organization to address significant liabilities which have been plaguing the corporation and are now compounded by the current economic environment.

This process which has different names in different jurisdictions allows them to address the debt load and pension liabilities which have been built up over the years. Hackney mentioned this restructuring is a decisive move by the board of directors to deal with the cost and debt burden and effectively restructure its operations.

Hackney reiterated the $2.4 billion allows the company to stay in business and support customers while restructuring the capital structure of the corporation. "This move keeps customers from further risk" he said.

Hackney also reiterated the company has struck a deal with Flextronics, the company who makes much of Nortel's gear. This was done to ensure continuity of products to Nortel's customers. Hackney concluded by saying, "While this is a difficult decision, it is the right decision and the best chance for Nortel to come out of this process much more focused, financially sound and competitive."

In response to an article in the Canadian newspaper Globe and Mail mentioning Nortel will be chopped up and sold to international competitors Hackney said, "We will not speak to rumors and the Globe and Mail is very effective at selling newspapers."

He further went on to say the strategy he has discussed with me in the past is still the company's strategy and this [action] is the best way of delivering upon that.

We spent some time on our call going over the nuances of what is bankruptcy and what is not and it seems to me more important to point out that through this process it seems likely the company will be in control of its destiny and I further I expect Canadian law to be quite flexible with Nortel. It remains to be seen what happens in other parts of the world.

Obviously there is increased risk in such a process but we have seen companies enter bankruptcy before and emerge stronger while doing so in a fairly seamless way to customers.

A point worth making is if the company is about to divide into 10 pieces and sell them, he can't legally tell me. But realistically, Nortel itself is the result of various mergers with companies such as Bay Networks who were substantial equipment manufacturers at one time as well.

Point being, product lines with customer bases almost always find buyers who want to keep customers happy and will continue to support and improve these products over time.

So regardless of what we call this - creditor protection, Chapter 11 protection, bankruptcy protection etc - what is happening behind the scenes is the company running today the same way it did yesterday.

The next obvious question is the company's burn rate because $2.4 billion in cash on-hand seems like nothing in these days of TARP funds and frequent industry-wide bailouts. To this Hackney mentions that the major items contributing to burn rate will now be reduced or go away and this is the most effective way to address it [the debt load].

Hackney says he spoke with five large CIOs of multi-billion dollar companies before our conversation today and he says these are savvy businesspeople who understand the need to restructure Nortel's capital structure. These customers said they need Nortel and were appreciative of being advised of the situation. They further requested to know what they can expect going forward.

Hackney says all earlier commitments to the partner and customer base will continue. He says this with confidence because they were doing these things with the significant debt burden they previously had. The issue for Nortel of course is does the stigma of Chapter 11 reorganization scare customers away or not. Obviously competitors love this sort of news but in today's environment, having financial difficulties and needing billions of dollars you don't have seems to be a common theme across many industries.

Hackney couldn't comment on what he thought this news would do to sales and mentioned forward visibility in this economic environment is uncertain.

When asked about how new customers should look at Nortel, Hackney replied, "We have always sold customers on the product capability, our technical support capabilities and our ability to save them money and make their companies more competitive." Hackney says this will continue to be the message and he is confident he can continue to demonstrate this fact.

He reiterates in a tough financial climate this will be a challenging objective but says his capabilities to add value to customers are as strong as they ever have been.

It is obvious Nortel will lose sales and share as a result of this news. That is a dead easy one to predict. How will the company respond? In the future, if sales do drop off more than expected we will see more job cuts and even salary reductions which we have already seen in the communications and automotive spaces.

Hackney assures me there won't be any more big announcements in the next few days (referring to negative news I am sure). He also wants to reassure customers again - it is business as usual.

In summary, I am comfortable with what Hackney is saying and am shocked there are no layoff or salary reduction announcements as part of this news. Nortel has done lots of things wrong and right over the years. What is important to keep in mind is they still have a huge line of products and customers, suppliers and partners who depend on them. The company will not evaporate overnight. Expect me to be keeping in touch with Nortel and passing along whatever I find out.



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