Nortel Networks Corp.'s Chapter 11 bankruptcy filing is supposed to give the troubled company breathing room to allow it successfully complete a reorganization it launched in 2005. The gambit, while offering temporary relief from creditors, could eventually help sink the company, ending one of the more compelling sagas in the North America telecommunications equipment market.
The Canadian company's bankruptcy filling on Wednesday (Jan. 14) in Canada and in a Delaware court was already a source of speculation among industry watchers, although many doubted Nortel would take the radical step. One reason was that the company still has more than $2 billion in cash, enough to continue funding operations through a recession-wracked 2009.
In November, credit rating companies, responding to concerns that Nortel's bonds were trading significantly below value, downgraded the company. But the agencies still believed Nortel could dodge the bankruptcy bullet since its available cash and short-term securities were at least triple its annual cash utilization " about $520 million, according to a Standard & Poor's estimate.
Nortel executives apparently concluded otherwise, opting instead for a bankruptcy reorganization that leaves its business intact while getting rid of problematic debt covenants.
"Nortel must be put on a sound financial footing once and for all," Mike Zaffirovski, Nortel's president and CEO, said in a statement. "These actions are imperative so that Nortel can build on its core strengths and become the highly focused and financially sound leader in the communications industry."
By filing for bankruptcy, Nortel will not have to immediately pay about $107 million in bond interest due this week, and it could gain additional leverage in negotiating future debt repayment with creditors. That action solves one problem, debt obligations, but immediately creates many more problems for Nortel.
The immediate problem is convincing customers, component suppliers and contract manufacturers that it can continue to function as a going concern and meet its obligations. The company noted in its statement that it already reached an agreement with electronics manufacturing services provider Flextronics International Ltd., which would guarantee continued manufacturing services to Nortel throughout its bankruptcy.
As part of the agreement, Nortel said it will buy $120 million in inventory from Flextronics by July 1, and commit to purchasing "other inventory and to terms relating to payment and pricing." The deal sweetens what is apparently a problematic situation for Flextronics, which in recent years bought several Nortel plants in anticipation of receiving regular multibillion manufacturing contracts from its Canadian customer.
"Flextronics has been doing anywhere between $800 million and $1.5 billion worth of annual business for Nortel, and the loss of a significant portion of this business will undoubtedly have at least a temporary negative impact on sales and margins," Matthew Sheerin, an analyst with Thomas Weisel Partners, wrote in a report. "We would not be surprised to see Flextronics announce the shutdown of some of the plants, resulting in potential restructuring charges."
Nortel's bankruptcy move will definitely leave many of its suppliers holding a questionable contracts they might not be able to enforce, a development component vendors already struggling with in a disadvantageous pricing environment might find unacceptable, but which they may not be able to fight.