Looks like Nortel CEO Bill Owens is making the rounds with the analyst community these days. The folks at UBS Warburg came away with a somewhat muted reaction. While UBS believes Nortel is now pursuing a larger addressable market by focusing on a bundled/complete solutions approach, it warns that this could cause the company's operating margins to be less than Nortel's public goal of 10% – thereby producing “mediocre” profits. If is not already abundantly clear already, Nortel is destined to be a smaller company in the future that will produce lower priced technology. While margins may be higher than selling big boxes to telecom carriers, Nortel could easily be a US$5-billion to US$8-billion company in the not too distant future. This idea has been a core part of IDC Canada analyst Lawrence Surtee's thinking in recent years. Surtees, who followed Nortel for nearly two decades as a reporter with the Globe & Mail, has been telling people for the past three years that the days of Nortel selling multi-million boxes will be over soon. On top of everything else that Owens has to address from a financial and strategic perspective, this new “price” reality will be a huge challenge.
You have to wonder about the magnitude of Nortel's restatement efforts in wake of the company's decision today to delay the release of its financial results for the past six quarters until next month. Nortel claims the delay is due to the “volume and complexity” of its restatement effforts. There is no doubt Nortel's accountants have a lot on their plate but it's a strange move for a company trying to regain credibility with investors, analysts and suppliers. The delay is either a cautious move to make sure further mistakes do not materialize, which would embarass Nortel yet again; or a disappointing move given Nortel had told investors certain events would happen on certain dates. In the meantime, it has been interesting to see CEO Williams Owens continue his “song and dance” campaign with reporters and analysts around the world. In an interview with reporters near Boston earlier this week, he talked about industry consolidation and how suppliers are talking to each other about all kinds of options. Ever since Cisco CEO John Chambers publicly spoke in June about a potential partnership with Nortel, there have been all kinds of speculation concerning a deal. Personally, I think it was another example of Chambers' strategic brilliance. While he puts the market and media into a frenzy about a potential mega-deal, Cisco has started to make acquisitions again after a bit of a slow period. Last month, it bought P-Cube for US$200-million. P-Cube makes technology that helps carriers provide higher quality and differentiated IP services without spending large amounts to upgrade their systems. While Nortel may be shy about making key acquisitions given its disasterous multi-billion dollar spending spree under ex-CEO John Roth, the company may have no choice but to beef up its IP portfolio. If Nortel had the financial resources, strategic courage and senior management focus, it should take a serious run at Juniper Networks Inc. With a market capitalization of US$12.5-billion, Juniper would be a huge bite for Nortel but it would shake up the telecom equipment sector and make Nortel a IP tour de force.
For those who were concerned the buzz about VOIP was beginning to wane, fear not. The fine folks at the Yankee Group issued a bubbly report earlier this week that forecasts there will be 17.5 million U.S. households with Internet telephony service by year-end 2008. The Yankee Group also expects 56% of the homes with the service will be cable customers, and Vonage's market domination will shrink. When it comes to predicting trends four years out, there should always be some uneasiness. Technology, market developments and pricing are so volatile and unpredictable, it makes forecasts a bad science. Anyone who bought in the enthusiastic e-commerce forecasts in the late-1990s knows this lesson far too well. There is no doubt Internet telephony will take hold if only because it will be so attractively priced (including bundles that include cable and high-speed Internet access) that many consumers will find it hard to resist. The challenge facing carriers is whether they jump into the VOIP business or start playing the pricing game with their traditional POTS technology. Truth be told, they probably don't have much of a choice.
You really have to wonder whether Microsoft has any sense of strategic momentum given its decision to delay the release of its new operating system, Longhorn, until early-2006. Even when it does come out, Longhorn will be a minor upgrade over XP. Then, you have Microsoft's controversial XP Service Pack 2, which is supposed to fix all the wrongs within XP. The big problem, however, is the computer community is torn over whether to install the upgrade because it is incompatible with many software applications. You figure Microsoft would have figured that out before it issued such a major release. Maybe it's arrogance, maybe it's ignorance or maybe it's incompetence but it ain't smart. It has been suggested that Microsoft split itself into different unit or simply issue a huge cash dividend and wind down the company. What route you want to fantasize about, there is something rotten within Microsoft. This is a company that has struggled, despite its market dominance, to come up with another killer app beyond Office and Internet Explorer. Investments in the online, cable and gaming sectors have not been major successes. It is hard to tell whether Bill Gates and Steve Ballmer have lost their competitive zest. Whatever it is, there are signs Microsoft may need a Lou Gerstner-like executive to come in and shake things up.
For the past few months, I've been a little sympathetic about ex-Nortel CEO Frank Dunn and his senior management team – believing they did yeoman's work bringing the company back to health before they were fired in April for reasons that have not been disclosed yet. In the background, however, was this troubling belief Dunn and his senior management team were also envious of the big financial rewards enjoyed by the previous management team led by ex-CEO John Roth. As most people know, Roth walked away with US$139-million in salary and stock options in 2001. Roth then retired to his huge mansion in Caledon, Ont. to – among other things – take care of his large car collection. As it turns out, Dunn apparently did have a bad case of Roth-envy. As Tyler Hamilton in the Toronto Star reported earlier this week, Dunn is builiding a mansion in Oakville, Ont. that could have a market value of up to $15-million. The first thought is: what was Dunn thinking? This is a man under the spotlight who couldn't resist the temptation to enjoy some rewards he apparently believed he deserved. The optics of building a large house look terrible. Think about it: as Dunn was handing pink slips to 10s of thousands of Nortel employees, he was pushing ahead with his dream home on Lake Ontario. Not good, Frank, not good. If Frank was smart, he should have kept his construction plans on hold or perhaps renovated his existing home. Clearly, Dunn saw what Roth enjoyed as Nortel CEO, and didn't think it was inappropriate to go for it. Ironically, Nortel ex-CFO Doug Beatty, who was also fired in April, still lives in a modest house in North Toronto. If anything, Dunn's real estate dreams suggest maybe the books were cooked at Nortel so senior executives could enjoy large financial rewards.
Can someone explain to me how Vonage manages to raise an addition US$105 million in venture capital? Each time this company convinces investors to pony up more cash, you have to be impressed by the selling powers of Vonage CEO Jeff Citron. With apologies, however, to VOIP advocate Jeff Pulver, Internet telephony is still an early-stage business where prices are already declining – before the major carriers and cablecos get really serious about jumping into the fray. I guess investors must look at Citron's track record – Datek Online and Island ECN – and figure he's a good bet for yet another financial windfall. To Vonage's credit, it got out of the gate first and has more than 200K lines. This means it is generating about US$6 million a month of revenue, and, given its modest expenses, probably making an operating profit or a bottom line profit. The big question is whether Vonage's business is sustainable? Will it be able to maintain its momentum or, at the very least, its current size when the major carriers decide to make the big push into VOIP? Personally, I think Vonage's investors have made a big bet – US$208 million to be exact so far – the company will be acquired by a carrier hoping to make a big splash into VOIP. If this scenario is likely, how much would Vonage be worth? If you use US$100 million in annual revenue as starting point, what's the price to sales multiple? 8X8 Inc., which has 17,000 customers, has a market capitalization of US$74 million. This works out to US$4,352 per subscriber. If Vonage is given the same multiple, it's currently worth US$1.5-billion. The next step is estimating how much equity Vonage has sold to raise US$208-million. If it's 20%, investors will break even at the current valuation. Of course, Vonage will sell at a healthy premium to 8×8 because it has a dominant market position and a more established and credible brand. Vonage also more growth potential if VOIP meets the gung ho expectations of the major consulting firms such as Frost & Sullivan. With US$105-million of new capital, Vonage will continue its aggressive expansion strategy in the U.S. and overseas. If the company can execute and grow to let's say 500K customers, it's value could easily double. Then, it will only be a matter of time before Citron cashes in big time again.