A Sigh On January 20: Nortel’s Bankruptcy

On this historic day of President Obama’s inauguration, here is a sigh for the world economy.

The economic crisis claimed its first major victim in the technology sector when Nortel filed for bankruptcy protection on January 14 in the US and Canada. A leading supplier of networking solutions with annual revenue of $10.9 billion in 2007, Nortel had debt of $4.5 billion and was due to repay a $107 million interest debt on January 15. Nortel had $2.6 billion in cash but chose to file for bankruptcy protection. Let’s take a closer look at why.

In a press release from the company, CEO Mike Zafirovski said that this move was essential to put Nortel in a sound financial position. As we saw in our recent Networking Sector Overview, Nortel’s sales have been on a decline and its market share has been eroding. Nortel has been trying to turnaround since late 2005 through drastic cost-cutting measures – it was recently trying to sell its optical and carrier Ethernet business, and its headcount is just 26,000 versus 95,000 in 2000. However, the lack of a clear strategy compounded by the global economic crisis has led to this step. 3Com, another networking player which was in the red has set the course of a turn around mainly because of its clearly defined low-cost strategy aided by their Chinese arm, H3C.

Certain EMEA subsidiaries are also expected to make consecutive filings while its 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.

With $2.6 billion in cash, Nortel could have made its interest payments, but sooner or later it would have defaulted. With an earlier bankruptcy, Nortel has saved on the interest payments and plans to use the cash reserve to provide ongoing support to customers.

But it is clearly the end of a company whose history goes back more than a century. Nortel was founded in 1895 as Northern Electric Manufacturing Company. Apart from the Ethernet unit, other divisions likely to go under the hammer are the carrier networks unit and enterprise division. Likely buyers are Cisco and China’s Huawei Technologies.

At the end of 2007, when we covered Nortel as an Online Video Beneficiary, its stock was trading around $17 and had a market cap of about $7.5 billion versus stock price of less than $1 and market cap of about $200 million at the end of 2008.

Unfortunately, we’re going to see more bankruptcy filings even in the technology sector this year. Some of the reckless borrowing that has come back to bite the American consumers plagues the business sector as well. And in some cases, companies needed to borrow for legitimate business reasons. But now, with the tight credit situation, banks unwilling to restructure loans, bankruptcy is the only way to deal with credit negotiations. And more companies will need to resort to it.