'Treading Water,' Nortel Leads a Broad Rally

Well, the Nortel NT domino fell Friday morning, though eggnog-chugging investors chose to focus instead on their reindeer games.

The Canadian telecom gearmaker forecast a narrower-than-expected fourth-quarter loss and said its wide-ranging restructuring is going according to plan. Nortel shares led a broad telecom rally, just a day after a sharp selloff rocked router upstart Juniper JNPR and within a week of negative outlooks from tech giants Lucent LU and Motorola MOT. Analysts had worried that soft results at those companies illustrated a marked deterioration across the industry over the past quarter.

Perhaps that's not so, the Nortel numbers suggested. But in their haste to celebrate Nortel's progress, investors overlooked yet another revenue shortfall and a reduction in a key credit line. Nortel rose 64 cents to $7 by midday.

What They Need

The bullish reaction looks a bit odd, seeing as it's well established that what Nortel and its ailing rival Lucent need more than anything else right now is cash. That's why the companies have spent the past year or so slashing their workforces to half their peak size, and why their financial press releases now focus on figures like the quarterly revenue break-even point. Just a year or so departed from their growth-obsessed boom years, these companies now fixate on reducing their outlays to match slumping spending by their big telco customers.

The Plunge Nortel's long ride down

So when Nortel said Friday that it had amended its 364-day credit line to reduce the amount committed to $1.575 billion from $2 billion, while extending the terms by six months to December 2002, it's hard to see where the progress is, some observers said.

"It looks like they're treading water again," said CreditSights analyst Glenn Reynolds. Explaining the stock's rally, he said, "People were waiting for a shoe to drop, and it didn't."

Needless to say, Nortel said it was pleased with the revised credit terms it negotiated with its bankers, and added that it hasn't drawn on any of its credit lines. "At the reduced level, we believe that the amount of this facility is appropriate for Nortel Networks in light of the progress that we have made on our work plan, the results of our ongoing focus on cash management and our current cash position," Chief Financial Officer Terry Hungle said in a statement.

The company conceded it pledged some of its assets as security for the credit line in the event of a downgrade. The debt of Nortel's operating units is rated two steps above junk level at Moody's and one notch above at Standard & Poor's.

Still, investors were pleased because there appeared to be no significant deterioration during the last quarter. "From a balance-sheet standpoint it sounds like they're still going along pretty good," Reynolds said. "It doesn't sound like anyone's hitting the panic button here."

Draconian Measures

Other numbers looked brighter. The company forecast a 16-cent loss from continuing operations for its fourth quarter, which is 2 cents narrower than the Wall Street forecast. Nortel also said restructuring "progressed well" during the quarter, though it pushed its revamp-end workforce target up to 48,000 employees from 45,000. Nortel said the change won't affect its plan to break even at less than $4 billion in revenue during the coming first quarter.

But revenue in the fourth quarter will come in at $3.4 billion, Nortel said, which is well below the $3.54 billion expected by analysts surveyed by Thomson Financial/First Call and less than half the year-ago $8.82 billion. Moreover, the company will have to show substantial sequential revenue growth in coming quarters to reach even its whittled-down break-even point, a feat that will be difficult to achieve with big telcos slashing their spending plans practically every day.

The solid rally across the telecom sector Friday indicates that investors believe the bad news, as they say, is priced in. But with the likes of Qwest Q warning that still more cuts may be in store, it may be time to cut back on the eggnog and take a long look at some of these balance sheets.