January 14, 2009 – Nortel Networks announced that it would seek creditor protection under Canada’s Companies’ Creditors Arrangement Act and the Chapter 11 of the U.S. Bankruptcy Code, with EMEA subsidiaries expected to follow suit. With a $2.4 billion cash position (unaudited balance at the end of 2008), day-to-day operations will continue uninterrupted and affiliates in Asia (LG Nortel) and CALA, as well as the Nortel Government Solutions business are not included in the proceedings.

• Current Perspective: Negative on Nortel’s bankruptcy filing in the U.S., Canada and Europe. To be sure, the move makes sound financial sense, allowing a deeper restructuring (potential split up and sale) while the company still has enough cash to continue day-to-day operations. In the longer-term, however, it calls into question what Nortel will look like as a competitor in the wireless, fixed-line and enterprise markets, as well as which products it will support going forward. These are, of course, questions no would-be customer wants to be asking.

• Vendor Importance: Very high to Nortel, because bankruptcy protection is something no company takes lightly. While cash on hand would have allowed Nortel to continue operations as normal, substantial debt service burdens and an inability to execute on planned divestitures (i.e., selling off its Metro Ethernet Networks division) meant that something proactive and drastic was necessary in order to move restructuring forward.

• Market Impact: Moderate on the enterprise market, because most competitors have already begun treating Nortel as a company that had become less than threatening. With a recent history of weak financials, restructuring and layoffs, an official declaration of bankruptcy merely affirms what Nortel’s rivals have largely been predicting, and the way they’ve been positioning it to would-be customers. Of course, now that bankruptcy proceedings have begun and the company’s long-term future remains a major question mark, these competitors are in a much better position to stir up additional concern and jump on potential deal opportunities that might otherwise have gone Nortel’s way.

We are taking a negative stance on Nortel Networks filing for bankruptcy protection. The move will provide the company relief from creditors, giving it time to restructure and devise new ways of returning to some semblance of its former glory; however, it remains unclear if Nortel and the courts overseeing its bankruptcy proceedings will decide to break up the company and sell it off in pieces or if Nortel will successfully emerge from Chapter 11 more or less intact. Nortel definitely plans on the latter, however until these issues are addressed the company remains in an extremely vulnerable competitive position across all of its product lines and businesses.

As announced on the morning of January 14th, Nortel has filed for Chapter 11 bankruptcy protection in the U.S., with similar actions pending in Canada and EMEA markets. The immediate rationale was to gain relief from creditors requiring that the company this week repay more than $100 million of debt. Nortel has also been severely affected by the economic downturn and has been generally unable to recover from years of corporate and financial woes that have included an 80% reduction in workforce, billions of dollars in net losses and accounting scandals. Nortel plans to use its period in bankruptcy to restructure its operations and “narrow its strategic focus.” Throughout the process the company plans to continue supporting its products and investing in R&D initiatives based on cash balances totaling around $2.4 billion.

Filing bankruptcy will provide Nortel with protection from creditors as it plans for yet another round of restructuring and otherwise seeks a means of salvaging its carrier and enterprise infrastructure business. Court supervision could even drive Nortel to restructure more rapidly and radically than it has in recent years, resulting in a company very different from the one that has existed for the past several years. Given that past restructuring efforts have failed to stabilize the company, the promise of drastic measures does not come as entirely bad news, particularly when the company has billions of dollars of cash on hand to fund operations, spruce up its product line and otherwise try to maintain a ‘business as usual’ atmosphere in the near term. If nothing else, this is good news in that continued operations and R&D investments should encourage customers to remain loyal as Nortel attempts to return to solvency.

There is, of course, more cloud than silver lining in Nortel’s bankruptcy proceedings. The move will have a demoralizing effect on personnel and greatly weaken the company’s credibility as a stable firm that is able to meet customers’ long-term networking and communications systems needs; filing for bankruptcy is testimony to the fact that previous restructuring initiatives have entirely failed to turn around the company. Nortel is now in an extremely weak competitive position. It will need to work hard to reverse the feelings that it is in a downward spiral from which it will be impossible to recover. What’s more, executive management has provided no clear insight into what new restructuring initiatives will succeed where all others have failed, nor is it clear what a “narrowing” of the company’s strategic focus will mean in terms of Nortel’s product portfolio and the company remaining a viable presence in the various carrier and enterprise markets it now serves.

Just as importantly, Nortel’s bankruptcy filing will have a generally negative effect on its customer base. Existing enterprise and carrier customers are unlikely to immediately abandon their Nortel products. This is because it is unlikely that any of Nortel's customers will be left high and dry, even in the event of a sale of one or more business units. But existing customers are certain to delay sizable investments in new Nortel products until they are sure of what the future holds for their beleaguered supplier of communications and networking solutions. With new customers likely to also delay purchases before Nortel has set its ship aright, this could exacerbate the company’s already precarious financial condition. However, if Nortel can truly emerge from Chapter 11 as a stronger and more focused company, there is hope yet for the company to reestablish itself in the market.

• Filing for bankruptcy protection should allow Nortel to undergo new restructuring and refocusing initiatives without being burdened by many of its current financial worries. Under bankruptcy protection Nortel will be able to undergo a more drastic corporate restructuring than it has previously attempted, one that could result in a very different but more financially stable company. Should all go well, Nortel could emerge from the bankruptcy process as a stronger company that is better able to serve its customers.

• Nortel claims $2.4 billion in cash reserves, which will be protected by the Chapter 11 filing. This will allow the company to fund ongoing operations, support existing product lines, continue R&D efforts and otherwise conduct business as usual throughout its period of bankruptcy. Just as importantly, the money should extend a certain amount of comfort to current customers wondering if their Nortel products will be supported, if development efforts will continue and if strategic relationships will remain in place.

• Filing for bankruptcy could help Nortel finally find a buyer for its Metro Ethernet Network (MEN) division. The company announced in September plans to sell the MEN business unit in order to raise capital and bolster its position in other market segments. However, finding a buyer has proved difficult, in part because some potential buyers have been waiting for Nortel to fail at which point they could purchase the MEN group at a fire-sale price. Filing for Chapter 11 creates a situation in which buyers could decide the time is right to pull the trigger on an acquisition.

• Whether or not it is good for the long-term success of the company, declaring bankruptcy is a major blow to Nortel’s credibility. The move signals that years of restructuring efforts and strategic initiatives have failed to turn around a company that has been suffering financially for the better part of a decade. Moreover, Nortel has announced no strategy promising to turn around its financial fortunes.

• Technically, declaring bankruptcy is just the first step in a restructuring process. Nortel could, conceivably, exit the process with a similar product focus and capabilities, but with less debt and a new structure. However, it could also presage a split up whereby certain Nortel divisions are sold off. Buyers could very well be vendors that simply want Nortel for its customer base and may not be able to (or want to) deploy, support or improve Nortel’s carrier and enterprise products in line with customer demands. Until the future of Nortel’s various enterprise and carrier business units becomes clear, customers will remain reticent to increase their investments in Nortel products.

• Beyond the future ownership of Nortel’s various businesses, bankruptcy could result in a vendor with a much different product focus; the company may have to simply exit certain businesses. In other cases – where it has customers it needs to serve – it may simply need to cut back R&D, clearly impacting product competitiveness and customer operations.

• With cash to support day-to-day operations, the bankruptcy proceedings may seem to impact Nortel’s long-term structure alone. This is not actually the case: in the near-term, Nortel’s day-to-day operations include sales engagements in every single business unit. With an uncertain future, however, it will be difficult for Nortel to close these deals successfully and much easier for competitors to argue that buying from Nortel today is a risky proposition.

• Nortel’s bankruptcy filings and planned restructuring simply signal that more changes and transformations are on the way. To this end, they present customers, partners and would-be customers with nothing more than a deep set of questions. What markets will the company remain in? What products will it pursue? What vendors are likely to acquire its assets? How will Nortel products be supported going forward? Until actual decisions are made (and these questions get answered), this confusion can only benefit competitors with more solid (long-term) market perspectives.

• Nortel needs to explain, loudly and clearly, what Chapter 11 bankruptcy protection means – particularly when paired with cash on-hand to fund near-term operations. The general market perception is that bankruptcy means a company is going out of business. In reality, Chapter 11 bankruptcy is simply a short-term move to allow for restructuring and improved financial positioning. For customers, this means that for the time being products will live on and operations will continue. At the same time, however, to provide an assurance of Nortel’s long-term survival, the company must also devise and articulate a recovery plan that will return the company to a stable financial footing, as well as result in carrier and enterprise customers recommitting to the company.

• Nortel needs to reach out to customers to assure them that existing Nortel communications and networking products will continue to be actively developed. Specifically, Nortel needs to send an urgent message to operators and enterprises that the company is still the logical choice for investments in state of the art networking and communications gear.

• Nortel should explain how – or more frankly, if – its Global Services organization will continue to deliver its broad portfolio in an environment where its people and processes are being redeployed to product units in the coming three months. Nortel platform product customers will be assured by the measure to ensure care and support for installed equipment, but carriers utilizing Nortel for application services and managed services will likely question the vendor’s ability to deliver going forward. Without a good answer to these questions, Nortel could consider selling its professional services assets to an independent integrator generating much needed capital as well as a sharper focus from which to re-engineer its future direction.

• Nortel will want to emphasize that its enterprise solutions are developed against industry standards and because of this they are open to integration with third-party products. Referencing these points, Nortel should discourage its enterprise customers from making hasty replacement decisions. Current investments in Nortel technology may very well be preserved, no matter the outcome of the company's present difficulties.

• Nortel’s current and would-be customers should not overreact to its Chapter 11 bankruptcy filing. It is clearly not a good sign for the company. However, it does not mean that Nortel is going out of business in the near-term. Instead, with cash on hand, the company will be able to support customer demands and (hopefully) come out of its restructuring as a stronger partner. If nothing else, the vendor will be unable to shed much light on its future plans until they unfold, making worried engagements a potential waste of time.

• While not obsessing over Nortel’s current restructuring, all of its customers need to closely follow the restructuring proceedings. In the near-term, this means putting on hold any major purchase decisions requiring on-going support from the vendor. Going forward, then, this means tracking the company’s structure in order to determine which markets the company will remain in, which businesses will be sold and how these decisions impact the attractiveness of its solutions.

• Where not already in place, Nortel customers need to establish secondary supplier relationships in their network or enterprise deployments. To be sure, this is a standard business practice. Now more than ever – with Nortel potentially pulling back from or exiting markets – operators need to take the practice seriously so that they can maintain service quality or operations should Nortel’s support disappear.

• Nortel's existing enterprise customers can be confident in knowing that they are a valuable asset. As a sought after commodity Nortel's enterprise customers will have multiple options available to them regardless of Nortel's long term direction. Customers should leverage this power to gain substantial incentives, incentives to either remain loyal to Nortel, or incentives from alternative vendors looking to displace existing Nortel gear.

• Enterprises considering new investments in communications, networking, and security solutions should continue to evaluate Nortel equipment. Any actual purchase during the bankruptcy period, however, must be done with eyes wide open and with an understanding of how the technology will be supported with or, perhaps, without Nortel’s direct involvement going forward. There are plenty of alternatives for enterprise systems and software for businesses willing to take on any additional risk, however small, posed by Nortel’s financial woes.

• Enterprises that are currently using Nortel as its secondary supplier should investigate other companies to put into the backup vendor position. Nortel's current difficulties make it difficult to rely on the company and a poor choice for a second-source vendor.