Analyst skeptical of Nortel seeing profitability in 2002

By Ronda Fears

Nashville, Tenn. Feb. 13 - While Nortel Networks still holds investment-grade credit ratings (Baa2/BBB-), Carol Levenson, director of research at the independent research firm Gimme Credit, views it as a speculative credit and is skeptical of the company's forecast to reach profitability in 2002.

A month after the company ventured to give some sales guidance, the analyst said Nortel on Tuesday admitted that simply achieving a none-too-ambitious 10% sequential decline in sales this quarter now appears challenging given the increasing tight-fistedness of its customer base.

"Having to get rid of the CFO because of his personal trading is unlikely to help either morale or market credibility, and Nortel desperately needs some strong financial leadership just now," Levenson said in a report Wednesday.

"With Nortel already backing away from some of its projections, we don't get a nice warm feeling about a return to profitability this year. We continue to view Nortel as a speculative grade credit.

Despite increasing concerns about equipment sales, Nortel has said it is confident it will achieve its primary goal of being profitable by fourth quarter. The analyst noted that sales were down nearly 60% in fourth quarter and down 6% sequentially, while gross margin was a meager 30%, down from nearly 50% the prior year.

"This miracle will come almost entirely from cost-cutting and, we are told, is not dependent upon an economic upturn or an uptick in carrier capital spending," the analyst said in the report, noting that Nortel's current cost-cutting program is expected to reduce fixed costs by a staggering $6 billion.

"We realize the restructuring program is not yet complete, but with revenues of $3.5 billion in the fourth quarter still producing a substantial loss, one has to question at what revenue level Nortel can indeed make a profit. Alternatively, perhaps Nortel needs to do even more cost-cutting."

Levenson also expressed concern about Nortel's cash position since the company still doesn't give out any cash flow information with its earnings release. It wasn't clear, she said, whether cash flow from operations in the quarter was positive or negative, although certain working capital items moved in a manner that should have generated well over $1 billion in cash.

"The $3.5 billion of cash on hand at year-end is impressive, but cash only rose by $160 million in the fourth quarter, after increasing by $1 billion in the third quarter," Levenson said. "Moreover, net debt only fell by $400 million. Thus, assuming there were some asset sales during the quarter, it doesn't appear that free cash flow was substantially positive."

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