Nortel Networks heads into 2006 with a new CEO known as a hands-on executive with a mandate to boost the battered company’s lacklustre profitability and restore its tarnished image among customers and investors.
Investors could be forgiven for thinking they’ve heard such promises before, but Nortel’s board is betting heavily that former Motorola president Mike Zafirovski can finally put the Canadian telecom equipment giant back on track. The Brampton, Ont.-based company has already agreed to pay $11.5 million US in cash as part of a settlement between Nortel, Zafirovski and Motorola, which had gone to court to block its former No. 2 executive from joining a rival.
The settlement also restricts unspecified recruitment efforts by Nortel and Zafirovski against former Motorola employees.
On top of reimbursing Zafirovski for the non-compete fees that he must repay Motorola, Nortel will pay him an annual base salary of $1.2 million US, plus possibly several million more in bonuses and stock options, according to filings with the U.S. Securities and Exchange Commission.
Harry Pearce, who became Nortel’s chairman last summer after a marathon annual meeting where shareholders spent hours venting their anger and frustration over the way the company has been run, has high hopes for Zafirovski.
“The board is absolutely of the view that we found the best candidate, bar none, worldwide,” Pearce said at the Oct. 17 announcement of Zafirovski’s hiring.
Pearce said much the same, two weeks later, after announcing the settlement with Motorola that cleared the way for Zafirovski to join Nortel on Nov. 15.
“I think Mike Zafirovski is a really strong hire and a great executive and he’ll get to the right things,” said Sanford C. Bernstein analyst Paul Sagawa.
But Sagawa added it’s too much to ask Zafirovski to reverse Nortel’s slide in market share in 2006 and restore its reputation as a technology leader.
“It’s hard to say why they seem to have lost their edge. It’s not like they’re a basket case but they’re clearly not the leader any more,” Sagawa said.
Among the factors, he suggests, is the accounting scandal that resulted in the firing of former CEO Frank Dunn and eight other high-ranking executives in 2004 and preoccupied Nortel for much of 2004 and 2005.
“Everything kind of slowed things down decision-making wise about the business,” Sagawa said.
He expects overall industry revenues in 2006 will be roughly 10 per cent to 11 per cent above 2005 levels – but Nortel will slightly below that
One reason for Nortel’s laggard status, he said, is that it’s not particularly well positioned in wireless networks – the part of the industry showing the highest growth – and has been losing market share in a lot of product categories.
“Over the last five years, a lot of Nortel’s wireless business has come from Cingular but Cingular’s putting in (third-generation technology) and Nortel’s not a part of it,” Sagawa said.
Similarly, SBC Corp. (recently renamed AT&T Corp.), is Nortel’s largest customer among the established U.S. carriers and “yet when they turned to do a next-generation IMS network, they went with Lucent.”
IDC Canada researcher Lawrence Surtees said Zafirovski – who spent 25 years at General Electric and then five years at cellphone giant Motorola before joining Nortel – understands a lot of the businesses and markets Nortel is in.
But the nature of the industry is changing, Surtees adds.
“The math of the new devices means that the revenue stream is much, much smaller for the same number of devices or networks that you’re contracted for,” he says. “Meanwhile, other parts of the business are being subjected to increased competition.”
All the big established telecom equipment suppliers – Alcatel, Siemens, Ericsson, Lucent and Nortel – are losing market share to Huawei Technologies and other Asian newcomers.
“The big fear is, if Huawei starts to enter the more established markets in Europe and North and South America, then there’ll be some more hurting,” Surtees said.
“It’s hard to imagine they only want to sell in their own region. Does it mean they’ll be successful? Who knows? But I think ’06 may see them try.”
Zafirovski’s predecessor Bill Owens put in place a number of initiatives to keep Nortel alive, get costs down so the company can better compete with Huawei and put it on a path to recovery and growth.
Among the biggest legacies Owens left Nortel, apart from grappling with the accounting scandal and getting its books in order, was a joint venture with South Korea’s LG Electronics.
He also grew Nortel’s presence in the U.S. public-sector market through the acquisition of PEC Solutions, a 1,700-employee business based in the Washington suburb of Fairfax, Va., for $448 million US.
Under the former U.S. admiral’s watch, Nortel also announced plans to divest most of its remaining manufacturing operations in a deal with Flextronics.
Nortel plants in Chateaudun, France, and Montreal were transferred to Flextronics in 2005 and the transfers of Nortel’s manufacturing operation in Calgary, including 652 employees, and a small plant in Campinas, Brazil, will be completed by the end of March 2006.
The Calgary site, which includes a research and development operation that Nortel is retaining, is focused on manufacturing, testing and repair of various types of Nortel wireless network equipment as well as data and voice networking products for Nortel’s enterprise customers.
When Nortel announced it had hired Zafirovski to take the helm, Owens, 65, bowed out graciously, saying “this is the right time for a new, younger person who is going to be able to be with the company for years, to drive the company forward.”
Zafirovski, 51, has moved to the Toronto area and plans to move his family next summer at the end of the school year.
“As you get to know me better, you’ll find I love to compete,” Zafirovski said in his inaugural press conference for Nortel. “And if you compete, you may as well play to win. . . And I am convinced Nortel is going to be a big winner again.”
Surtees said Zafirovski faces the immediate strategic question of whether Nortel should try to keep a presence in all of its product areas or exit some businesses.
Will Nortel, for example, continue to address the so-called enterprise market – made up of businesses, governments and other public-sector organizations – to focus on communications carriers?
Despite Nortel’s efforts to build on its installed based among enterprise customers, that business tends to generate no more than 10 per cent of overall revenues.
“You can argue a case for keeping it or getting out of it,” Surtees said. “I could see the new CEO asking some probing, searing questions about that.”
Yankee Group analyst Zeus Kerravala says that in the U.S. market – which accounts for about half of Nortel’s annual revenues – its strength is in its relationships with the major phone companies.
In the enterprise market, Nortel has lost some of its cachet, he said, partly as a result of a change in individuals doing the buying for the organization.
“I think enterprise is an area they need to shore up. They’ve had a lot of change there,” Kerravala says.”And I don’t know how you keep the train running when you’ve got churn throughout the organization like that.”
Kerravala says he doesn’t know Zafirovski but he’s heard that the new Nortel CEO is a “very process-driven guy” and, in Kerravala’s view, that will be good for the company.
“They need, I think, a strong operational person to come in and take a look at all the different people and job functions and what they’re doing and create some better operational efficiency around it.”