Investors Fretting Over Nortel's Wireless Marshall Plan

Not content to bankroll cash-starved telco upstarts on this continent, Nortel (NT) is racing to finance construction of next-generation wireless networks in Europe.

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With hundreds of billions of dollars of equipment sales at stake, global wireless network construction offers a tremendous opportunity for Nortel. As growth in the company's core optical-networking business tapers off, Nortel could use another fast-revving engine. Thus the company's decision over the next year to more than triple, to as much as $3.7 billion, its lending commitments to customers.

But to some observers, boosting lending to cash-strapped phone and Internet service companies smacks of desperation. Several analysts and investors say Nortel, Lucent (LU) and Cisco (CSCO) are simply trying to pump up sales in the face of a broad telecom-gear spending slowdown. Offering cash to customers is one way to keep demand growing.

Further, whether Nortel and others can gain European infrastructure business without taking on crippling debt or decimating their profit margins remains an open question. And if rival Ciena's (CIEN) travails are any gauge, a whole new shakeout among emerging telcos could be developing in Europe, potentially leaving lenders holding the bag as upstart builders go belly-up. Accordingly, investors are wondering whether Nortel should be staking billions in loans on the buildout of next-generation wireless networks over there.

Mainly on the Plain

Nortel has already agreed to extend an estimated $1 billion in financing to two Spanish wireless carriers, Airtel and Xfera. As established players in Spain, backed by large corporations with millions of customers, both companies make for good borrowers, Nortel says.

But some analysts say any payback on these investments is many years out, and even that return assumes that the ambitious wireless Internet project dubbed third generation, or 3G -- which promises high-speed Web surfing on handheld phone/computers -- gets built at all. "3G could end up being the high-definition TV of wireless, as in always coming next year," says one New York based hedge fund manager who has no position in Nortel.

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In Europe, spending in auctions for 3G spectrum has reached "absurd levels," says Bruno Lippens, an analyst with Bank Dewaay in Belgium. Bids total 100 billion euros ($87 billion). "Add to that some $250 billion euros to get a network up and running, and you may conclude that 3G, if it's ever going to be profitable, will certainly never be a major profit generator," says Lippens, who estimates break-even points for the various 3G carriers to be five to 10 years away.

Nortel, putting the best face on its 3G financing activities, says it backs quality players whose strength will help them resell loans to banks or offload them into the debt market, rather than carrying them on their books indefinitely. But some say that's a bit like pulling out the plastic after it's already been maxed out with holiday purchases: Banks and high-yield debt markets are already up to their necks in telecom and 3G-related debt.

Blind Trust

Doubly troubling is that vendor financing arrangements have always been sort of a dark alley: The average investor seldom is privy to the full terms of these deals, which sometimes verge on self-interested. For instance, big equipment makers have been known to lend to network builders they've received financial stakes in.

"This is scary stuff," says the New York hedge fund manager, who asked not to be identified. "A lot of these guys are giving 125% financing to customers," he adds, referring to terms that can include cash beyond the cost of new equipment. For example, Nortel's $500 million vendor financing agreement with upstart mega-network builder Aerie included an undisclosed amount of money for operations.

Another red flag for some investors is the potential erosion of profit margins as vendors find they must compete more on financing terms and less on product merits. The suspicion is that the equipment sellers end up giving away great financing terms to win the contract, effectively killing their profit margins in the end, says Chase Fleming money manager Antony Gifford, who owns Nortel stock.

Nortel declined to comment on specific financing deals but maintains that margins haven't been threatened.

"We'll not take any risks that are imprudent," says Frank Plastina, Nortel's president of wireless Internet. "We have the luxury to walk away from deals that make absolutely no sense."

The PC Crowd

To be sure, Nortel's loans represent a small gamble on what could be an enormous payoff. To play along, you have to be willing to believe what Plastina says: that Web phones are going to be Europe's PC.

Here's how he lays it out: Europe never warmed to the PC like we did in the U.S., largely because Europeans get soaked for every minute they are online thanks to old-world phone laws. Here, our connections are considered local calls, so we surf for free as long as we want typically. With 3G, if there is any online banking to do, Plastina says, Europeans will pull out their mobiles, whereas here, we would access our accounts from our desktops.

However, there are a few caveats you should know before staking too much on Nortel's bet, says the unnamed New York hedge fund manager. The available bandwidth, or capacity, in any given area will be shared, not dedicated. That means potentially flimsy connections, not perfect for executing real-time stock trades, for example. Also, handhelds will always give you the Internet in miniature, which presents limitations. And European telcos could suddenly go to free unlimited access, immediately weakening the strength of the handheld PC argument, says the hedge fund manager.

With more than $2 billion in its lending budget next year, and a growing roster of cash-starved customers, Nortel will have to be a very discriminating banker if it hope to keep investors' faith.

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