Going broke is good news?

One study shows filing for Chapter 11 may be Nortel’s saving grace

Going broke is rarely considered a gift from the gods, but it’s possible that Nortel Networks has just been blessed. The telecom titan recently filed for bankruptcy protection in Canada, the U.S., and Europe—and a recent study shows that may have been exactly the right thing to do to finally turn the company around. “It gives them some breathing room to reorganize and focus on the business changes that might need to be made,” says Mike Lemmon, a finance professor at University of Utah and a one of the study’s authors. “Rather than worrying about having to generate enough cash just to make next month’s interest payment.”

The study, published online by the Social Sciences Research Network, looked at 530 companies that declared bankruptcy between 1991 and 2004, and classified each in one of two ways. “Financially distressed” companies were good businesses that would be profitable if their debt were removed. “Economically distressed” companies wouldn’t be. The study found that 80 per cent of the former group emerged from bankruptcy with only seven per cent fewer assets—so they were the stronger for it. Meanwhile, only 37 per cent of the economically distressed companies managed to reorganize with less than half of their original assets. The rest were liquidated or bought up. “The bankruptcy process seems to be doing what it’s supposed to do,” says Lemmon, “which is allowing good firms with financial problems to restructure and keep their businesses going. And getting rid of bad firms.”

Nortel, the researchers say, falls into both categories. “For instance, their top competitor, Cisco, has a much better operating performance than Nortel,” says Ph.D. student Yung-Yu Ma, who co-authored the study. But Nortel also has a lot of debt: US$3.4 billion as of the fiscal quarter that ended last August. But when that red ink is stripped away, and you just look at Nortel’s EBITDA, a popular measure of profitability, it doesn’t look bad at all. So “it’s profitable,” says Lemmon, “but less profitable than its largest competitors.”

The team is reluctant to predict whether Nortel will emerge from bankruptcy intact, but they do believe that even if the company restructures its debt, some assets will have to go. Nortel has been ailing for several years, and although multiple CEOs have been brought in to turn the company around, each has failed. “Filing for bankruptcy doesn’t make you look particularly good,” explains Lemmon. “Some managers just want to protect their jobs for as long as possible.”

Still, Lemmon is encouraged by the comments made by CEO Mike Zafirovski when the bankruptcy announcement was made­. “I’m convinced by choosing this path at this time that we can put Nortel on sound financial footing once and for all. It will allow us to deal with decisively with our cost and debt burden, restructure our business and narrow our strategic focus in an effective and timely manner,” said the CEO.

“He’s certainly saying the right things,” says Lemmon. Hopefully it’s not all talk.




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Going broke is good news?

  1. Thanks for carrying a balanced article about Nortel – it is so rare.

    Reports about Nortel’s possible demise are greatly overstated. Friends inside Nortel say it is still a good company. It has a good revenue stream as many products are doing well. However it carries too much debt – a legacy of past mistakes.

    By seeking bankruptcy protection, the company has an opportunity to get back in shape. This has worked for Air Canada and should work for Nortel, too.

    There is also a good case to be made for giving government help to Nortel. If the government can bail out the auto industry, then why not Nortel that employs some of the best and brightest minds in the country?

    Read more at http://www.wecanadians.com

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