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Monday, July 31, 2006

Nortel: Taxes Aren't The Issue, Survival Is

Stocks: (NT)(MOT)(ALA)(LU)(NOK)(SI)

Nortel is engulfed in another set of problems with its P&L and balance sheet. It seems to be an annual ritual like the gulls returning to Capistrano. The result of the confusion over tax credits was raised in the Wall Street Journal, based on a study by research firm Glass, Lewis. If Nortel continues to lose money, the tax credits could go away and send the company's shareholder equity. The company is holding on to the credits on the basis that it will be profitable soon.

The conversation is interesting, but it begs the question of whether Nortel is a viable entity under any circumstances. Nortel's shares hit a 52-week low on the tax credit news, dropping to $1.92. The company's shares are down almost 50% over the last 12-month period from a high of $3.57. The stock was at $4 in the Fall of 2004.

Nortel's core business in optical network equipment is a fairly good one, but the costs to run the business as a standalone business are clearly too high. And, its balance sheet is hardly a thing of beauty. According to Morningstar, cash and cash equivalents are $2.7 billion. Long-term debt is $2.5 billion.The company has $5.2 billion in accrued liabilities and only $675 million in equity. The company still commands a market cap north of $8.4 billion.

With the Alcatel merger with Lucent, and the Siemens joint venture with Nokia to combine telecom infrastructure unites, Nortel is the odd man out. And, the stock trades that way.

The balance sheets and pricing power of these new entities, created by "mergers" of telecom equipment vendors, puts Nortel's back to the wall. It cannot afford to see margins drop in the hopes of pricing its products to gain share. It simply does not have the financial power to do it.

Motorola, the other bride left at the altar in the consolidation of telco equipment giants, may be Nortel's last, best hope. Without a well-financed parent, Nortel has little chance of surviving.

Douglas A. McIntyre canbe reached at He does not own securities in companies that he writes about.

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