Tuesday, December 16, 2008

Why Nortel could opt for bankruptcy

From the Globe& Mail's Streetwise blog:

Is bankruptcy the right option for Nortel Networks?

There's a lively debate breaking out amongst analysts and banks as Nortel apparently weighs creditor protection as an option. The thinking is the company could resort to bankruptcy as a proactive move, if current plans to shed divisions, cut costs and build deeper customer relationships don't bear fruit.

Now, Nortel is taking pains to point out that its financial situation is relatively strong, even if the economic outlook is dire. The company has no debt maturing until 2011, and $2.7-billion (U.S.) in cash.

However, a report that investment bank Lazard and outside legal counsel have been hired to provide Nortel's board with guidance on a trip through bankruptcy court, along with downgrades from credit rating agencies, have fed speculation that Canada's former tech darling will go bust. By the way, the jungle drums in U.S. capital markets have Nortel filing for bankruptcy any day now, while there's far less alarm in domestic legal and banking circles.

National Bank Financial's Kris Thompson stepped back Tuesday and explained the logic for this seemingly radical move.

“While our view remains that bankruptcy protection is premature at this stage, today's capital markets are quite different from past downturns,” said Mr. Thompson. “Banking industry participants are suggesting that distressed companies are considering pre-emptive bankruptcy protection since debtor-in-possession (DIP) financing is tough to come by in today's credit market.”

The theory is Nortel would resort to creditor protection in order to reorganize from a position of strength, with cash still on its balance sheet. Mr. Thompson said the Nortel board is in the difficult position of balancing what's best for creditors and the company as a whole against what's best for shareholders. Because in any bankruptcy filing, shareholders can count on being wiped out.

“Is Nortel's fiduciary duty to both equity and bond holders, or do bond holders become a priority when a company is faced with a likely bankruptcy?” Mr. Thompson asked, then answered his own question by saying: “We don't recommend shareholders stick around to find out.”

National Bank Financial has a 25 cent (Canadian) target price on Nortel, which changed hands Tuesday down 13 per cent at 37 cents on the TSX. For those with short memories, shares changed hands at $1,220 just eight short years ago - that price reflects a 10-for-1 consolidation.

The carnage in Nortel's stock price, and bankruptcy concerns are also reflected in the price of its bonds. As my colleague John Partridge reported, Nortel's benchmark 10.75-per-cent bonds due in 2016 traded at just 16 cents on the dollar Tuesday morning, down from 20 cents a day earlier and 27.5 cents a week ago, according to data from TRACE, the fixed income tracking system provided by the U.S. Financial Industry Regulatory Authority (FINRA).

Now, not everyone believes that Nortel is headed for the rocks, and will need to seek creditor protection. Paradigm Capital analyst Barry Richards pumped out a note last month, when the company released quarterly financial results, that started by saying “the market believes Nortel's equity has no value, which is a view we do not share.”

Paradigm's analyst has a $5 target on the stock, and forecasts up to $1-billion in successful asset sales in coming months. Mr. Richards said “We do believe the business will be right-sized and restructured and the implied value is much higher than the current implied value...The company still has considerable resources and three businesses with real products and real customers, generating $2-billion to $5-billion a year in revenues.”

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