Ringing in a change

Financial shocks hit Northern Telecom

July 12 1993

Ringing in a change

Financial shocks hit Northern Telecom

July 12 1993

Ringing in a change

Financial shocks hit Northern Telecom

There was a carnival atmosphere in the darkened auditorium last week as Jean Monty, accompanied by throbbing rock music, colored spotlights and wisps of smoke, strode to centre stage. What the crowd of 2,200 did not realize at the time, however, was the brilliance of the juggling act performed before their eyes by the new chief executive officer of Northern Telecom Ltd. of Mississauga, Ont., a leading global telecommunications equipment manufacturer. In fact, even as Monty calmly and confidently informed the annual gathering of customers of Northern Telecom’s Meridian telephone system about his strategy for the future, the company was under attack. In just one day of frantic trading on June 28, Northern Telecom’s share price plummeted by 20 per cent to $37.12 from $47.37 a share and its stock market capitalization dropped by $2.5 billion. By the time the Toronto Stock Exchange closed on Friday, the company’s shares were trading at $34.38 each and its market capitalization was down by more than $3 billion. The drop was so severe that one group of outraged U.S. shareholders filed a lawsuit against Northern Telecom alleging that they had been misled about the company’s financial prospects. Said Michel Guité, a vice-president at Dillon Reid & Co., an investment dealer in New York City:

“It’s like those movies where the enraged peasants light torches and storm the castle.”

Northern Telecom has suffered setbacks in the market before—but never such a dramatic or extended free-fall. Through much of the recession, the company’s aggressive expansion into international markets and its relatively solid financial results earned it a devoted following among individual and institutional shareholders across North America. That devotion, however, was not unconditional in the face of uncertainty about future performance. And uncertainty was what Monty had asked investors to accept when, on June 25, he revealed that Northern Telecom would report its first loss in five years, for the second quarter of 1993, and that all earnings forecasts for 1993 should be revised downward.

At the same time, Monty also announced the abrupt resignation of Northern Telecom’s chairman and former chief executive, Paul Stern. Longtime company director and former chairman of Procter & Gamble Co. 0. Bradford Butler replaced Stern. Then, just four days later, Monty orchestrated a major shuffle among Northern Telecom’s senior executive ranks. Company management has now been organized along global product

lines rather than by geographic regions. Said John Strimas, vice-president of corporate relations at Northern Telecom: “These moves put into place the first building blocks of Mr. Monty’s tenure.”

In an era of intense global competition, Monty’s tenure is an especially critical one in Northern Telecom’s history. Over the past 12 years, the telecommunications industry has been characterized by the emergence of fewer larger companies vying fiercely for contracts in an environment of deregulation, international trade and fast-paced technological change. There are now seven major worldwide telecommunications equipment manufacturers, down from 15 companies in

1990 and 30 in 1980. As telecommunications networks are installed and updated in developing economies like China and Eastern Europe, the global market is forecast to grow from around $85 billion in 1990 to $300 billion by the end of the decade. And according to industry experts, a company needs at least a 10-per-cent share of that market to remain competitive.

To stay in that global game, Northern Telecom has been forced to learn how to negotiate and how to operate facilities in a host of foreign languages and markets, from Turkey to Brazil. At the same time, it has had to balance the demands of efficient production and competitive pricing with aggressive research, development and marketing of new products. In 1992, the company spent $1.6 billion on research, development and engineering, up from $1.3 billion in 1990. Said John Drolet, a Toronto-based technology analyst with Credifinance Securities Ltd.: “You have to pay to play. You can never stop spending because of the phenomenal pace of change.”

To date, Northern Telecom has proven to be adept at keeping pace with its rivals through cost-cutting campaigns, international acquisitions—such as the $3.1-billion purchase of Britain’s STC PLC in 1990—and a variety of international joint ventures. The company also has the benefit of a stable controlling shareholder, the widely held Montreal-based BCE Inc., which owns 52.4 per cent of its stock. BCE’s dominance allows Northern Telecom to focus on broad strategic planning and goals without excessive shorts'’ term pressure to post quarterly 2 gains and to boost share price. Furthermore, through its parir ent, Northern Telecom has a I close relationship with BCE’s á wholly owned telephone utility,

I Bell Canada—Northern Tele-

II corn’s largest customer.

Despite that close relationship with Bell Canada, the

recession has taken its toll on Northern Telecom’s overall sales volumes and also has brought about more aggressive pricing in bids on all contracts. In fact, in its statement on June 25, the company attributed the projected second-quarter loss to “lower than expected” sales of the company’s central office switching equipment (which represents 50 per cent of its total sales) and competitive pressure on sales prices. Already in 1992, gross profit margins on sales were down by $23 million from a year earlier, to $4.1 billion or 40.5 per cent compared with 41.8 per cent in 1992. Despite those immediate financial pressures, the costs of research and development are recorded as they are


incurred although the payout on a major investment may take years.

The lack of detailed information provided by the company about Stem’s sudden departure as chairman, and the projected financial loss, quickly ignited speculation that the company might be preparing to announce more sweeping changes in the near future. In particular, that speculation has focused upon a major restructuring of Northern Telecom’s far-flung operations and a possible downward revision of the value of assets. According to financial analysts who follow the company, Monty, who replaced Stem as chief executive officer in January, may now take advantage of a singular opportunity to clean house and to take strong financial medicine, without taking responsibility. Noted Guité: ‘There’s a natural predisposition to lay all the blame on an outgoing CEO, a tendency to sweep several problems into a tidy portfolio and dispose of it.”

In his first public appearance following Stern’s departure as chairman last week, Monty took pains to draw a clear line between Stem’s regime and his own. While Stem had a reputation as a brash, intimidating careerist, an image that was enhanced by the 1990 publication of his controversial prescription for corporate success, Straight to the Top, Monty is known as a polished and approachable team player. Said one of Northern Telecom’s marketing executives: “During internal presentations, Monty is

businesslike but friendly. With Stern, you knew he was always waiting to broadside you and show that he was smarter.”

Prior to joining Northern Telecom as president and chief operating officer in October, 1992, Monty, 46, served as the chairman and chief executive officer of Bell Canada. He joined Bell in 1974 after working in the corporate finance department of investment dealer Merrill Lynch Canada Ltd. in Montreal. A native of Montreal, Monty has a master’s degree in economics from the University of Western Ontario in London and a master of business administration from the University of Chicago.

Northern Telecom’s 58,000 employees apparently are not the only ones to express ambivalence about Stern’s hardline approach. While he aggressively promoted Northern Telecom’s international expansion with his Vision 2000 strategy, which aimed to make the company the top global telecommunications supplier by the end of the century, many observers suggest that he badly neglected customer relations. Monty, however, is clearly attempting to restore the company’s focus on both customers and consultation.

In his bid to pull closer to end users, Monty told the Toronto gathering of Meridian telephone users last week that, as the former head of Bell Canada, he has extensive experience as a client of Northern Telecom. In his address to the group, he said that he understood their needs and the value of their input to the company. Declared Monty: “One of my priorities is to lead a program to develop a customer-first culture in Northern Telecom.” He added: “We must learn from you and be responsive. Customer choices and feedback must drive product development.”

Monty recently oversaw the launch of an in-house “customer-first” program that, over the next 18 months, is intended to establish a new inhouse system for logging and responding to customer comments. The appointment of another former Bell Canada executive, Brian Hewat, to the helm of 70-per-cent-owned BellNorthern Research Ltd., Northern Telecom’s research and development laboratory, is seen as another step in closing the gap between end users and product development.

Monty’s speech to Meridian telephone customers also was significant because it deliberately modified the company’s strong

emphasis on the international scene. Just two weeks after Northern Telecom concluded an agreement with the Chinese government to expand Northern Telecom’s presence in that burgeoning market, Monty said: “North America will be the core market for Northern Telecom for years, if not decades to come.”

In 1992, operations in Canada and the United States generated 80 per cent of the company’s 1992 revenues of $10 billion. But it is in North America that the company faces the most ferocious competition and, some observers say, the most rapidly maturing telecommunications market. Although New York’s Guité insists that telephone systems across North America are undergoing a “constant, massive upgrading” and that demand will continue, there are some short-term concerns.

Key customers like Bell Canada have curtailed spending on capital equipment because of the recession; as well, the recent deregulation of long-distance telephone markets in Canada has heightened competition—and uncertainty—in a formerly monopolized market.

Analysts anticipate that surging demand in emerging foreign markets like China will offset the current downturn in North America over the long term. Under its new

agreement with China, Northern Telecom will invest $50 million to $100 million there during the next two years and it will undertake a third joint-venture project later in 1993. By the end of the decade, China is planning to buy the equipment required to

install 96 million new telephone lines at a rate of six million to 10 million annually. That represents four times the number of lines installed in Canada. According to Credifmance’s Drolet, a modern economy requires a minimum of 10 to 20 telephone lines per 100 people to function efficiently. Canada has 58 lines per 100 people while China now has 0.8. “If Northern Telecom can grab even a fraction of that market,

the upside for earnings is massive,” he said.

Foreign markets, however, are not without complications. Beyond North America, governments frequently play a decisive role in awarding contracts, and their decisions are often influenced as much by political agendas as by price and quality considerations. On another level, international currency swings can also have a dramatic, arbitrary effect on the economics of offshore investments. Despite the widely acknowledged strategic merits of Northern Telecom’s British investment in STC, the weak performance of British sterling has sharply reduced the profits returned to Northern Telecom in U.S. dollars.

After last week’s flurry of developments, investors and analysts will now have to wait until July 29 when the company will release more detailed information about Northern Telecom’s second-quarter performance and any corporate restructuring plans following its monthly board meeting. Said Guité: “That company has driven the last 50 laps at 150 m.p.h. with the roof down. They’ll accelerate again before Monty’s finished.” For now, however, Northern Telecom appears destined to make a pit stop.