I was invited to ROB-TV (Report On Business Television) on Thursday evening for an interview at Howard Green's 7 PM program (The Business News with Howard Green).  Earlier that day, Nortel (NYSE:NT) had warned investors that it might not meet analyst expectations for Q3, and that its Q3 results might be sequentially down from Q2.

Funny what a difference a few months makes.  Last time I was a guest at Howard's show, Nortel stock was going through a fast climb, as investors bid up its price due to the Verizon announcement and the bullish sentiment towards the company's VoIP prospects.  Back then, some financial analysts had some pretty unrealistic expectations and over-quantified the impact of that win (I specifically recall mentioning the words "irrational exuberance" on that occasion, borrowing the words from Fed Chairman Allan Greenspan to describe the big jump on the stock price right on that day).  Back then, I cautioned that the effort required to gradually migrate the existing carrier Class 5 infrastructure towards a converged IP architecture would take more than a decade instead of just a few years. 

Moreover, some people were saying all of Verizon's class 5 upgrades to VoIP would go to Nortel, which is a bunch of nonsense.  No carrier puts all their eggs in one basket and the same holds true for Verizon.  Lucent had been the incumbent class 5 switch supplier, with Nortel being the number two supplier.  Chances are that at best, the 18 month exclusivity deal signed with Nortel would put the company in the driver's seat, but still with Lucent as the secondary supplier and perhaps even Sonus getting a smaller third piece of the VoIP pie. 

I also mentioned that the impact of that deal to Nortel's bottom line could be of the order of $150-200 million in revenue in 2004 and $250-$300 in 2005.  Some good Wall Street insiders found out from the Verizon CTO that the true-IP Nortel solution was still being qualified in Verizon's labs and that it would likely not start being deployed until Q4 of this year, with packet over ATM transport solutions being used in the interim. 

Well, so what about the latest news?  Nortel had previously indicated that it would grow faster than the market, which was expected to grow in the mid-single digits.  The implication was a growth rate of between 5 to 10% for Nortel versus 3-6% for the market.  However, on Thursday, Nortel changed its guidance, mentioning that its own 2004 revenue growth would be in the mid-single digits, lower than what the market will likely grow at.  Immediately, Bay and Wall Street took the news badly, and the stock suffered. 

I was not as spooked by the news, despite the fact that my position might seem to be a bit like that of a market contrarian.  Nortel's strongest line of business right now is wireless (responsible for roughly 50 percent of the company's sales).  According to some insider information that I have received, chances are that this latest announcement likely is a reflection of a loss in an RFP from Cingular.  Nortel had made it to the final list for that 3G contract, but there are some indications that Lucent (or perhaps Ericsson or Nokia) were chosen instead.  But what about this possible contract loss?  Well, again, remember that this is UMTS, and Nortel was in the running, and the company will likely still win some Euro contracts in that area.  Interestingly enough, Nortel previously had missed on the GSM opportunity, as it was primarily a CDMA player in the wireless space.  So the news is not all that bad as it seems on the surface. Evidently, there were a few other factors behind Nortel's warning as well, probably including lower CAPEX expectations from wireless and wireline service providers. 

But Nortel remains well positioned, not only in the wireless arena, but also in VoIP, both on the enterprise and the wireline segments.  The company has a large installed base of Meridian One TDM PBXs and also Norstar key systems, and as this base begins to mature, Nortel will be well positioned to capture some lucrative IP upgrade and/or replacement opportunities.  More importantly, Nortel is also ahead of some of its competitors (such as Lucent) in the carrier space, where its softswitch can eventually replace the legacy Class 5 gear.  Lucent still has some catching up to do there, as evidenced by its acquisition of Telica in late May.    

The only question is whether or not CEO's Bill Owens aggressive commitment to reducing operating costs to 35% of revenues in the medium term (or 25 to 30% in the long term) is achievable just with the recently announced 3,500 employee job cut.  It might be eventually necessary to have another mini-cut in the future to achieve that goal, albeit it might affect a smaller number of employees (from 1,000 to 1,500).

The bottom line is that just as the great increase in the stock was not quite justified back in February, neither is this major correction.  Barring any unforeseen major surprises in the company's restatement of results in October (which is also currently overhanging the stock), Nortel's stock should eventually go back higher.

Note: You can view the clip of the interview at this link.  Scroll down all the way to the bottom of the page and you will find me at the 7 PM program (Howard Green).  Howard mentions my name right at the start of the program and then, he interviews me for roughly 5 minutes at about the 23 minute mark (you can fast forward the video feed, right after the Bloomberg commercial).  This link will be up until early morning this upcoming Thursday, the 23rd of September.