Business

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Nortel’s sudden crash fuels more jitters about the outlook for tech stocks

Jane O’Hara November 6 2000
Business

Back to Basics

Nortel’s sudden crash fuels more jitters about the outlook for tech stocks

Jane O’Hara November 6 2000

Back to Basics

Business

Nortel’s sudden crash fuels more jitters about the outlook for tech stocks

Jane O’Hara

Was the stock overvalued? Or did the market sim-

ply overreact? Those are the questions investors are still asking in the wake of the dramatic nosedive in Nortel Networks Corp.’s stock last week. Vancouver management consultant Deborah Pike, 49, whose stock portfolio contains a fair chunk of Nortel, just shrugged when she heard the tech giant had stumbled. There were no panicky calls to her broker. She had no sleepless nights. Instead, she seemed philosophical about the downturn. “I’m in it for the long haul,” she said last week, “so the ups and downs don’t really bother me. Besides, it’s like the weather. There’s nothing I can really do about it.”

A lot of other players tried. Nortel’s precipitous descent began early Tuesday evening, shortly after the company released third-quarter results showing weaker-than-expected sales of fibre-optics equipment and a lower-than-expected growth forecast. After-hours traders started the initial wave of selling. By the time the markets in Toronto and New York City opened on Wednesday morning, the stage was set for a free fall. Within IMi hours, Nortel’s stock had dropped $24.55 on the Toronto Stock Exchange to $71.55, erasing 26 per cent of the stock’s value. Total loss: a mind-numbing $83 billion of market capitalization.

The pain—on paper at least—was felt in millions of Cana-

dian living rooms. Brampton, Ont.-based Nortel is one of the country’s most widely held stocks, by both individuals and mutual funds. And because of the company’s massive growth in recent years, it accounts for a huge proportion—lately anywhere from 24 per cent to 34 per cent, depending on its price—of the TSE 300 composite index. When Nortel sneezes, the TSE often gets sick.

Sure enough, the race to off-load shares was so intense it crashed the exchange’s glitch-prone computers. By midday Wednesday, red-facedTSE executives were forced to halt trading in the stock. And by day’s end, the TSE 300 was down 840 points—its biggest one-day point loss ever and, at 8.1 per cent, its second-worst crash after Black Monday’s 11.3 per cent on Oct. 19, 1987. Nortel CEO John Roth, the 58-yearold engineer responsible for transforming the once-sleepy phone-equipment maker into an Internet powerhouse, moved quickly to limit the damage to his company’s reputation. In a series of satellite interviews from Nortel’s offices in Brampton, Roth downplayed the debacle. “You have to look at the stock market and say they go through these things from time to time,” he said, “but it’ll pass.”

Many analysts agreed, saying the company is fundamentally healthy. By week’s end, some buyers had moved in to pick

up the stock at fire-sale prices, although the mini-rally faded: Nortel closed down again on Friday at $65.50. Jeff Wagman, vice-president of Toronto-based Taurus Capital Markets Ltd., viewed Nortel’s fall as a normal correction for an overheated stock that was trading at a whopping 100 times earnings. It’s the latest in a long line of tech giants— Nokia, IBM, Intel—to be humbled by investors showing a continuing nervousness with the tech sector. “For new investors who’ve only seen a one-way market, Nortel’s selloff might be a shock,” Wagman said. “But people who’ve been in the markets get used to these things. It’s a normal part of the cycle and tech is now at the end of its cycle. The market is telling us we’re in a slowdown. These things don’t go on forever.”

Wagman recalls similar drops in Nortel’s share price in both 1993 and 1998, when the stock price was almost halved. Then, as now, he used the calamity to pick up stock for his clients at far cheaper prices. “I’m pretty bullish,” said Wagman. “I’m a buyer at these levels. Nortel is still a great company doing a lot of good numbers.”

Despite the market reaction, in fact, those numbers were still mighty impressive. For the third quarter, Nortel showed an operating profit of $869 million, up 64 per cent from last year. Revenues increased by 42 per cent, to $ 11.1 billion. But while that number sounds good, some on the street were expecting as much as $ 11.8 billion. Moreover, Nortel forecast 2001 growth at 30 to 35 per cent, while analysts had put it at 40-plus. Those shortfalls caused institutional investors and mutual fund managers to push the sell button.

“The problem here is not necessarily with Nortel,” said Dave Powers, a tech analyst with Edward Jones & Co. in St. Louis, Mo. “The problem was with investor expectations. The stock was priced for perfection and now the news is less than perfect.” If the point needed any illustration, on Thursday evening Nepean, Ont.-based JDS Uniphase Corp., another giant in fibre optics, delivered numbers that beat earnings estimates, as well as a glittering forecast for annual revenue growth of 115 to 120 per cent. The stock immediately took off, although it fell back as Friday’s mini-rally lost steam.

Roth defended his company’s revenue picture, insisting that demand for optical networking systems was still strong. Part of the problem, he said, came from “installation botdenecks” caused by a shortage of engineers to build the networks. He also said some customers, afraid of shortages, were hoarding equipment. “Building fibre-optic networks is a huge undertaking,” he said. “We’re now caught up at the rate at which the marketplace can absorb this technology.”

Roth is used to challenges. In 1997, he became CEO of what was then Northern Telecom, a company whose core business was manufacturing switches and phone equipment for telephone carriers like Bell Canada. But Roth believed traditional phone systems were about to be left in the dust by computer networking systems that could carry huge amounts of voice and data over the Internet. Changing the name to Nortel Networks, he plunged the company into Internet-based systems. He also went on a spending spree, paying well over $30 billion to buy up software and fibre-optic suppliers. The new strategy paid off. Nortel is now a world leader in building fibre-optic networks, with about 40 per cent of the market, and goes head-tohead with such U.S. heavyweights as Cisco Systems Inc. and Lucent Technologies Inc.

Although Roth is cagey with predictions, analysts at UBS Bunting Warburg Inc. say he is still guiding the market to expect high growth—40 to 50 per cent this quarter—in the critical optical-networking field. They warn that with such “very aggressive” targets, Roth better not disappoint or he will once again face the wrath of the market. “Credibility of management, which was dampened this quarter, is on the line,” said the UBS analysts.

Also at stake is the reputation of the TSE, Canada’s largest stock market. Its suspension of Nortel trading on two days running forced brokers and day traders to route deals through the New York Stock Exchange. On an average day, the TSE processes 7,000 Nortel trades, but on Wednesday, the computers choked on 65,000. The aging system is a mishmash of technologies. The TSE is in the process of switching from a dual computer system to a new single system that should be in place next year. But many brokers are losing patience. “They either get in the game or they’re going to die,” said David Driscoll ofToron Capital Markets Inc. And for many traders, as Nortel showed, getting in—or out—fast is what the game is all about. ED