Juniper Warning Rings Alarm Bells for Nortel Holders

As Juniper JNPR reminded us Thursday, 'tis warning season, and all eyes are now on Nortel NT, the last of the big dominoes to fall in the network gearmaking industry.

Industry watchers say Nortel will soon forecast a fourth-quarter shortfall and lower its financial guidance for 2002. The big question is: Just how dramatic of a warning does Nortel have in store? Nortel shares closed off 50 cents at $6.36, while Juniper dropped $4.08 to $18.85.

One of the risks for Nortel is that a weak fourth quarter could put it below the financial performance targets it has promised to its creditors. As illustrated by the sharp decline in energy stocks since the collapse of Enron, investors get nervous when companies run afoul of their lenders.

To be sure, Nortel is no Enron. The telephone gearmaker hasn't had accounting shenanigans, and its business isn't as capital-intensive as Enron's far-flung trading enterprise was. But still, if Nortel violates loan covenants, it may face another sitdown with its bankers, which could lead to new financing terms on a 364-day syndicated note that's due this summer. Another possible outcome is a request to attach parts of Nortel's business as collateral on the loan.

Credit Talk

If Nortel's numbers really stink, the credit-rating agencies could slash its ratings, which could put a double whammy on Nortel by boosting borrowing costs and restricting access to capital. Nortel debt hovers just a notch above junk status and is currently on a negative watch.

"If they violate any covenants, such as the minimum tangible net worth covenant, NT will need to negotiate a waiver that would most likely include pledging assets to the banks as security, paying a higher rate and even seeing the availability under the facilities reduced," says CreditSights analyst Glenn Reynolds. "That means NT could end up junk rated with less available liquidity at higher rates over the near term."

Nortel declined to comment on the likelihood of a warning or the various scenarios regarding its covenants.

Wall Street has heeded these concerns, having pushed Nortel's shares down nearly 20% since last week, when telecom-equipment rivals Lucent LU and Ciena CIEN dramatically reduced guidance.

Not So Sweet

Juniper's shortfall announcement Thursday echoed the observations made by Ciena and Lucent, that an overall weakening of demand for new gear brought on by a rash of deep spending cuts by cash-strapped phone companies continues to keep the tech suppliers in a sales nosedive.

Telcos across the board have slashed their 2002 spending plans by 20% to as much as 50%, as they grapple with declining revenues, narrowing margins and ballooning interest payments. Notably, Qwest Q last week cut its capital-spending budget again while launching a new round of job cuts. The Denver-based local phone giant has been struggling against a rising tide of red ink.

When it reports its fourth-quarter next month, Nortel is expected to report a loss of 18 cents a share on revenue of $3.5 billion, according Thomson Financial/First Call. But at least two sell-side analysts with Merrill Lynch and Credit Suisse First Boston have already taken their revenue expectations down to the $3 billion range, citing the inevitable deterioration of Nortel's business, considering the industry outlook.

Like Lucent?

The reason many on Wall Street are so confident that Nortel has bad news in store is the top to bottom similarities the Canadian telecom gearmaker has with New Jersey rival Lucent. The two companies make nearly identical equipment in hundreds of product lines, and they share almost the same exact customers.

Lucent, as you'll recall, last week projected a 23-cent per share first-quarter loss on revenue of $3.1 billion to $3.4 billion. Wall Street expected the phone-equipment maker to lose 17 cents a share on sales of $4.4 billion.

For its part, Juniper said Thursday that fourth-quarter revenue will be $150 million to $155 million, down from original guidance of $200 million. Pro forma earnings per share are now expected to be 5 cents, half of what analysts expected, according to Thomson Financial/First Call.

Perhaps one silver lining for Nortel shares in all this is that much of the bad news may already be reflected in the price. In fact, at this stage, Nortel's shining accomplishment for the year may be that it didn't close out the annual books as disappointingly as expected.