Sinking in Scandal: The Death of Nortel
Big thank you to Nebula for sponsoring this video. When the Edmund Fitzgerald launched in 1958 it was the largest ship to sail on the Great Lakes, just a one foot below the maximum allowed length of 730. The ship was named for Edmund Fitzgerald Sr, president of Northwestern Mutual out of Wisconsin, and spent 17 years hauling iron ore, setting its record of around 28,000 tonnes.
Because of its imposing size, recognizable colours, and the music is played over its speakers, the boat became a local legend on both sides of the US-Canada border, and earned it the nickname the “Titanic of the Great Lakes”. During its history the ship was not without its close calls or minor accidents. But each time it survived and continued its journeys.
And then came November 10th of 1975. After spending over a little over a day sailing east on Lake Superior, the Fitzgerald and another ship, the Anderson, began to enter into rough waters. With wind speeds reaching almost 80 km/h, the captain of the Fitzgerald radioed the Anderson to say: “I have a 'bad list', I have lost both radars, and am taking heavy seas over the deck” They lost radio contact at 7:10pm. Minutes later the Fitzgerald entered into a squall, a highly localized black storm cloud, at which point it disappeared from the Anderson’s radar, and the ship and its 29 crew members were never seen again. The wreck was found 4 days later, 500 feet below the surface, a dozen miles outside Whitefish Bay.
It had been torn into two gigantic pieces. The lifeboats hadn’t been launched, suggesting that whatever took it down happened too fast to react. Although they’re called the Great Lakes, their sheer size is such that they’re more comparable to inland seas. Lake Superior is the largest of the 5, with enough volume to fit the other 4 lakes with room to spare. The weather conditions are often unpredictable, and even violent. The waves on lake superior that day, particularly on the eastern side, reached an astonishing height of 11m.
That’s as tall as a four story house. With the Fitzgerald weighed down with 26,000 tonnes of cargo, water would have crashed down above the deck by over 4 meters. And although it’s exceedingly rare, if the air pressure system was just right, a rapid frenzy of wind can generate a rogue wave, over twice the height of the surrounding crests, a column of water so imposing that it would register on a ship’s radar. The exact mechanics of the sinking, to this day, are unknown, and widely disputed.
Even the famous Gordon Lightfoot song captures the multiple possibilities with this lyric: “They might have split up or they might have capsized; they may have broke deep and took water.” What exactly sank the Edmund Fitzgerald is a mystery that will never have just one satisfying answer. The best we can do is analyze the wreckage, and make our guesses. *To music* "North East South West everywhereeeeee, Northern Electric serves you besssssssst."
In April 1999, Nortel’s General counsel, Clive Allen, dropped a bit of a bomb during a roadshow in Ohio. Now Allen was set to retire in just over a month, and allegedly thought that his remarks would stay within his relatively small audience. He said that Nortel, and other tech firms quote “owe no allegiance to Canada”, and alluded that Nortel may be considering a move to the States, unless the feds slashed its tax rates. “Just because we were born there doesn't mean we'll remain there.
Canadians shouldn't feel they own us”. The comments from Allen were not received well by the Canadians. One 72 year old shareholder said his remarks were "gratuitous and nasty" and that "Nowadays, everybody just thinks of themselves," Kristal said. "I feel what Allen said was very offensive."
Nortel may not owe allegiance to Canada in a legal sense, but it certainly benefitted from its close ties in Canada. It was collaborations with the National Research council and grants and loans from the government that helped kickstart the microelectronics boom in Ottawa, and Nortel had enjoyed years of R&D tax credits. One estimate in 1993 pegged the total tax credits at around $880 million, and it would be well over a billion by Y2K. NAFTA was supposed to even the playing field, give Canada a chance to expand into the US.
Between 1985 and 2002, there had been 10,000 foreign takeovers of Canadian companies, 6437 of them by US companies. 97% of the $140 billion CAD of new investment money that had flowed into Canada was spent on foreign takeovers. Was Canada open for business, or was it up for sale? And now, the one Canadian company that had broken the cycle, was talking about abandoning them. No one wanted a repeat Quebec Nordiques moving to Colorado, only to go on to win the championship the very next year. The very idea that Nortel’s would move down south was insulting, but not unprecedented.
50% of Nortel’s sales were in the US compared to just 10% in Canada. The majority of its employees were now American. The recession years under Jean Monty had seen their fair share of Canadian plant closures and relocations. Bramelea, London, Amherst, Canada saw a quarter of its workforce cut, many of them unionized, in favour of the cheaper labour available in countries like Mexico and China.
And since 1997 Nortel had begun to spend less and less money on political donations in Canada, instead sending more money to Democrats and Republicans with each passing year. Following the controversial comments John Roth had to go into damage control mode, saying that Allen “communicated very poorly” and was not authorized to speak for the company. Instead, John Roth tried to reframe the issue. "Well a big issue is that there is a huge incentive for basically people in the upper income, and a lot of our jobs that we have in Nortel basically pay very well, and there's a huge tax differential now between the take-home pay someone would experience if they had that job performed in Canada vs is they had performed that job in the United States. And I think the government really has to pay attention to the fact that a lot of upper income jobs are moving to the US. And this is going to reduce the Canadian tax base in time and is goin to basically impact the standard of living that we all enjoy here in Canada."
This was not about Nortel leaving to the US, but instead that Nortel was losing its best and brightest to US companies. On average, one Nortel manager a week was being poached by US companies in the year 2000. One Nortel executive was approached midway through his vacation in Greece, and was flown out to Silicon Valley that day. They also offered to have his wife flown out so she could view a selection of handpicked houses and to see the various school districts. It doesn’t matter that you work for the richest tech company in Canada, US tech has unfathomably deep pockets.
One Silicon valley recruiter explained it like this: “Optical networking equipment is not something a couple of guys in a garage can create overnight.” “There is no one in the valley who knows how to do optical transport. We have to import all our guys”. Canadian engineers were being offered huge raises, stock options, and yes, even hockey tickets.
That last one does sound like a sweet deal on paper, but keep in mind, the hockey team was probably the San Jose Sharks. I’ve been assured that this is a very funny sports joke. The company behind that particular stunt was Optical Networks, of which Cisco was an investor, and Nortel was so infuriated by its antics that they filed a court injunction to prevent them from stealing its employees. It had poached 19 employees in 11 months. Worse, Nortel was alleging that those employees had been targeted because of trade secrets.
The last time Canada underwent such a brain drain was after the Avro Arrow. When the project was shut down in 1959, rather than converting the plant to civilian aircraft, 14,000 of Canada’s best engineers were unceremoniously laid off. Guess who benefitted from that? Those Canadians immigrated down South, and went on to play a not so minor role in the founding of a little organization called NASA.
John Roth was arguing that this saga was repeating. In John Roth’s eyes, it was no wonder highly educated Canadians were immigrating down south. They got higher salaries, better stock options, and their taxes were lower. Highly paid tech workers would be unlikely to require things like public housing and job offers from Silicon valley companies often include cushy private health insurance. If Canada wanted to keep those PhDs north of the border, they obviously had to cut taxes. That was his argument at least, but the validity of it is hard to evaluate.
One study between '97 and 2002 found that on average 23,000 university educated workers had left Canada each year for the US job market. In 1998 Statistics Canada confirmed that yes a brain drain was occurring, however it was small, much smaller than the one during the 50s and 60s and more than offset by a brain gain from people immigrating to Canada, by a factor of 4. And on top of that, a later study from 2013 found that this brain drain was often temporary, with around 50% of graduates who moved to the US later moving back to Canada. There are clearly some additional, harder to quantify variables at play here. But here’s the thing.
This is about a narrative. And John Roth had a narrative that the media loved. Nortel had ballooned to spectacularly that it was worth more than the rest of its own parent company, BCE. His quotes were being published every other week in newspapers. He was on TV talking about the brain drain.
John Roth was not simply a Canadian CEO, he was *the* Canadian CEO. His rhetoric was being echoed by the leaders of the two Conservative parties, who began to demand for further tax cuts, like the Americans had just implemented a few years earlier. The culmination of this was a widely publicized feud with finance minister Paul Martin.
The role of finance minister is generally one of the most sought after cabinet positions, and Paul Martin was particularly influential. After coming in 2nd behind Chretien in the party leadership race, Martin had been biding his time ever since, stoking internal divisions in the party, and would successfully force out his boss in 2003. What this means is that John Roth was sparring with a future prime minister. “Canadian taxes are too high, they are driving out top talent, the Gretzky’s of high tech”. And Martin would hit back.
“Do I believe that some people leave Canada and that these are the kind of people we should not lose? Yes…Do I believe that they leave because of taxes? No.” As much as the government tried to argue against it, politics is about optics. In February 2000 Paul Martin introduced what amounted to $58 billion dollars in tax cuts, and a significant overhaul to the tax bracket system.
With an election becoming increasingly likely as the year dragged on, Paul Martin delivered a killing blow to the Conservative platforms by unveiling a second mini budget in October, which added even more cuts, and sped up many of the changes promised in February. By 1-upping the opposition on taxes, and with healthcare as further wedge issue, the Liberals cruised to another huge majority in November of that year. John Roth had gone toe-to-toe with the future Prime Minister and he had won. For this saga Time Canada named him Canadian Newsmaker of the year.
Although most Canadians were focused on changes to the middle tax bracket for the John Roth’s out there the real headline was the corporate tax rate, which would be dropped from 28% to just 21% over the next five years. Employee stock options also got a revamp. They now had a built-in tax deferral clause, meaning you wouldn’t owe taxes until you sold the shares.
And of course the capital gains tax, which as we saw last time, contributed significantly to the Canadian stock craze. It started the year at 75%, but was down to 66% in February. This would have been the end of it, but then the Tory government in Ontario said, hey, we’re going to lower ours down to 50%. Not wanting to be outflanked on taxes in an election year, Paul Martin said, fine, we’ll do it first.
And so by October he had slashed it again, and brought it down to 50%, which is where it stands to this day. [HOME intensifies] In a global financial market that was so often dominated by American companies, John Roth had done everything he could to level playing field. But still, Nortel lacked one key trick that Lucent and Cisco had access to. And John Roth had a plan for that as well. "Analog and DMT, how much better can it be?" Anesthetic on the floor, I can't take it anymorrrre" "I don't think I want to pay this anymore."
To understand the root of Nortel’s problems, you have to go back to a PR incident in late 1998. See this plunge in price? It was caused by just 12 words. The recent Bay Networks purchase was not an immediate slam dunk. The company had not been without its own issues, it had been formed from the merger of two other tech companies who had overlapping product lines, and some of its senior employees had jumped ship.
At $9.1 billion many observers thought Nortel had way overpaid. And by Fall 1998 it wasn’t clear if Bay was helping Nortel’s cash flow. Nortel had just released some earnings numbers that didn’t factor in the Bay purchase, even though the two companies had already merged. At their annual investor meeting in late September, Nortel’s then CFO, Wes Scott, got up on stage to try and clear up the confusion. Referring to their projected annual growth of 14%, he said something to the effect of “in the high teens” with Bay included, and “low teens” without Bay. Technically, this was not new information, and yet he hadn’t even finished his sentence and a room of 500 people had entirely vacated, all the analysts had left to tell anyone who would listen to cash out of Nortel, and do to it fast.
In the days that followed Nortel lost 20%, or 9 billion dollars CAD in value. Since announcing the Bay purchase, they were down 50%. One audience member remarked “It was only 12 words. That works out to $750 million per word”. It was a hard lesson for Nortel. This stock price crater had undone basically all the gains that had been made under John Roth’s tenure as CEO, he was approaching his threshold.
The lesson learned here was that frank honesty is bad for the stock price. You gotta give investors only what they want to hear. Wes Scott booted from the CFO role early the next year. He would be replaced by Frank Dunn, a long-time ally of John Roth. From this incident onwards, Nortel would concoct a new type of financial reporting.
Earnings from operations. I already know that for most of you watching this, your eyes just glossed over. I get it, it sounds like an ECON 101 term, something straight out of an accounting textbook. But it’s deceptive.
These three specific words, in this specific order, is not something you can find in a textbook, it’s an invention entirely unique to Nortel, a smokescreen that hid just how bad things were from investors. So there’s this thing in the US called GAAP, right? Generally accepted accounting principles. Essentially a big group of accountants, the FASB, come together and make a set of standardized rules for reporting a company’s finances.
It makes it so you can compare different companies on a level playing field, and helps investors make informed decisions. It’s not technically a law, but if you’re a publicly traded company, the SEC can issue fines if you don’t follow GAAP, and even private companies tend to follow it so they get loans from banks. Now Canada at this time had its own version of GAAP.
Nortel, which was owned by a Canadian parent company at the time, was required to follow Canadian GAAP, which was frustrating for Nortel because it meant they couldn’t take advantage of the highly controversial Opinion 16. AKA: The pooling rule. When you buy a company, you’re paying for two types of assets. Tangibles, and intangibles. Tangible assets would be physical stuff, like offices, factories, equipment, employees, stuff that has a clear dollar value.
The intangibles though are harder to quantify. This might be brand recognition, customer relationships, or in this new exciting dotcom era, the future potential of R&D. If I buy for a company for $10 million, but they only have $3 million in tangible assets, that means I’ve paid a premium of $7 million. This premium is called goodwill, and goodwill has to be recognized on your balance sheet, subtracting from your revenues as a rapidly depreciating asset. Here’s where the controversy comes in.
Way back in 1970, the FASB had drafted Opinion 16, a rule that dictated how companies report expenses after a merger. When two companies of equal size merge together, say, Exonn and Mobil, they take all their shares, and combine them into one big pool. The assets have been combined, no money has traded hands, and so it doesn’t count as goodwill. However, by the 90s corporations realized that the pooling rule could be abused, it didn’t just work for a merger of two equals, it could be applied to one company buying another. A big company prints new shares, and swaps them with the employees of the small one. There is no pooling taking place here, shares have traded hands, but because those employees were now part of the big company, the pooling rule technically applied.
As long as you paid with shares instead of cash, the pooling rule effectively made the acquisition free. It was like goodwill never existed. Now that FASB wasn’t dumb, they realized what was happening and wanted to scrap pooling as early as 1996.
The problem was that they faced intense lobbying efforts from tech companies, who sunk millions into the pockets of Republicans and Democrats, particularly in California. The tech sector sunk around $40 billion into political contributions in just the year 2000. Despite this, the FASB continued to fight back, and eventually managed to get the pooling rule scrapped, a change that would take effect on January 1st 2002.
Of the big three, only Cisco could make use of pooling, and it took advantage every chance it got. Nortel couldn’t because it was stuck following Canadian GAAP, and Lucent couldn’t until late 1998. This was a condition of its spinoff from AT&T, that it couldn’t use pooling for the first 3 years. You can see how this would be endlessly frustrating for Nortel and Lucent. Just 3 months after their ban on pooling expired, Lucent made its first major purchase in January 1999 with Ascend Communications. Now it was just Nortel without a free money glitch.
So what did Nortel do? They did it anyway. The thing is, there’s nothing preventing a company from publishing their GAAP numbers, and then also publishing a different set of numbers, numbers that make their company look better. So long as you clearly define which ones are GAAP and which ones aren’t, there’s nothing illegal about that. You could bury them in fine print, or you could publish your annual report on a big news day so that no one pays attention. This type of creative accounting fueled the entire dotcom bubble.
You had startups worth billions of dollars on the stock market and yet had no products and no revenues. They were just offices with a few computers, a website, maybe a foosball table. The 1990s were the wild west of investing, and it became almost impossible for financial analysts, much less the average person, to decipher the dozens of different GAAP vs non-GAAP numbers.
It was like apples, vs oranges, vs prime rib steaks. To be clear, what Nortel was about to do was not unique, and not illegal. Nortel was just doing it at an unimaginable scale. And so, under the new CFO Frank Dunn, Nortel released their annual report for 1998. In it, the cost of the Bay Networks buyout was simply not factored into the headline numbers.
Buried at the bottom, were the GAAP numbers. What would have been a $569 mill loss under GAAP was a $1 bill profit under Nortel’s nonsense numbers. Here’s another, the headline reads: Revenues up 22% up to $4.4 billion. But buried at the end of the paragraph is the GAAP number: The quarter actually saw a loss $470 million. As Nortel continued to buy around one new company a month, their financial situation continued to worsen.
Paying a premium in shares costs way more than paying with cash. Shares are inherently more risky, their value can go up or down at the drop of a hat. A company about to be bought out is going to demand a premium. Qtera for instance had been valued at around $68 million the year prior, only to be bought by Nortel for $3 billion. I have a hard time believing they went up in value 40 times in just a year.
Of the nearly $22 billion spent on goodwill, only $450 million of it was paid using cash. One estimate by analyst Al Rosen says that if they had paid with cash, Nortel would have saved $13.4 billion. Were these acquired companies even profitable? Were they bringing in new revenue? Nortel made it impossible to tell. They weren’t kept as distinct subsidiaries, they were absorbed into the existing corporate structure, their revenues all mixed together in an opaque sludge. And the acquisitions were hardly…efficient. Many product lines overlapped.
Nortel now had 2, maybe 3 divisions working on competing products. Of course, all of this is doesn’t matter when so long as the stock price is going up. As we saw earlier, Nortel’s already distorted presence on the Toronto Stock Exchange allowed it to exploit these buyouts to further inflate its share price.
As long as the stock stayed steady, and the orders from customers kept coming in, they’d never feel the cost of those acquisitions. And here’s the kicker. Executive bonuses weren’t paid according to GAAP numbers. They were paid according to Nortel’s custom accounting.
By selling his shares in August 2000, John Roth cashed out $36 million. If we go by his yearly salary, it would have taken him 30 years to earn what he had just made in one day of trading. In the 4 years he was CEO of Nortel, he earned around $130 million. In during his 4 years as Nortel’s CEO, Nortel hadn’t posted a single profit.
"I gather the results might have been better if you had been able to fulfill more orders. How are you going to deal with those bottlenecks?" "Well we've been working that very aggressively as you might imagine. This is one of the problems you'd like to have from time to time but we don't want it to last too long." "Success a nightmare? It may seem that way if don't have the right tools to handle it."
The dotcom bubble had burst on March 28th 2000. All those internet start ups have finally burned through their venture capital money. The tech heavy NASDAQ index began to plumet.
All those internet start ups had finally burned through their venture capital money. That year 14 dotcom companies ran Superbowl ads for around $2 million each. And later that year 2/3rd of those companies were bankrupt. The business models never took off, and only the most hardened players, the Amazons, the eBays, managed to stick around. Logically you would think that when the dotcom bubble burst, the telecom bubble would immediately follow. But that’s not quite what happened.
Just because a bunch of California yuppies in their parents garages couldn’t put together a business plan doesn’t mean the sky is falling. The Nortel’s, the Cisco’s, the Lucent’s, we’re planning for the future here. Just like the race to build the early cross continental railroads, this was a race to install the world’s fiber optic networks.
If you build it, they will come. The three-way race continued well into the summer. By July there were rumours of yet another massive buyout. Nortel was in talks to acquire Corning. Corning is *the* company when it comes to glass.
They were the ones who made the glass for Thomas Edison’s lightbulb. These days they were known for mass producing the thin strands of glass used to transmit binary laser pulses. Fiber optic cables. The magnitude of this deal can’t be overstated. It wasn’t meant to be however. Rumours of the deal caused Nortel's stock price to rocket up even higher, causing Corning’s investors to panic, and the deal was abandoned.
This is absolute peak that Nortel will reach. $124.50. They will never get back above this line.
Go ahead and take in the view, because it will only lasts a few weeks. Nortel had spent the past year as the darling of the Canadian stock market, but if you go looking for them, you can find a handful of Nortel skeptics who predicted the inevitable fall with stunning accuracy. Al Rosen had been one of the first to raise the alarm on the “earnings from operations” nonsense, and he advised his clients to stay away from Nortel. Ross Healy was notable for going on live TV and predicting a drop to $8 per share by September.
But it was Paul Sagawa who truly understood the danger Nortel was in. He had spent months talking to dozens telecomm companies, asking anyone who would pick up the phone. The answers he got didn’t just spell doom and gloom for just Nortel, he predicted a black cloud for the entire telecomm sector in 2001. The demand for internet traffic was growing, absolutely.
But nowhere near the levels that market analysts were pulling out of their asses. One consulting firm predicted that between 1999 and 2003, you’d see traffic go from 350,000 terabits to 15 million terabits. That’s a 10 times increase per year, 4 years in a row. Author Douglas Hunter points outs the telecomm industry was a near perfect analog to the race between British railway companies in the early 1800s. Companies often ran parallel tracks to the same destinations, but there simply weren’t enough passengers to use all of them.
What happened next was mass bankruptcy and consolidation of the rail industry into just a few powerful players. Nortel was still the darling of Bay and Wallstreet, but its detractors had begun to knock a few dollars off its share price by the Fall. And with its share price slumping, Nortel had to slow down on its acquisition spree. After closing two more deals in early October, there wouldn’t be another for several months.
John Roth was as defiant as ever. “It isn’t that Nortel is overvalued, it’s maybe that everything else is undervalued”. Late October was critical for Nortel, investors were eagerly waiting for Nortel to release their 3rd quarter numbers, and hopes were high. But October 25th turned out to be a disastrous day.
Nortel was going to miss analyst expectations by 1 cent per share. It was an underperformance just barely below expectations but the market is unforgiving. Nortel loses $80 billion in one day.
The TSE has its worst day in 13 years because of it. So many Nortel shares were being traded that it brings down the TSE’s computer systems and traders have to go through Wallstreet instead. By the end of the week $120 billion of value was simply erased from existence, and Nortel fell from 32% to just 24% of the TSE 300. Autumn was a chilly wake up call after a blistering hot summer season. October 25th is the biggest single day loss in Nortel’s history.
But as dire as that sounds, it was not the end of the world. It’s important to take moment and get some perspective. This graph is so warped, so blown out of scale that every number that isn’t this one feels like a colossal failure. But every time Nortel has fallen down in the past, its stock has climbed its way back up. Think about how the people who bought the dip in 1993 feel now? If you bought here, Jean Monty quadrupled their shares by the time he left. If you bought the dip in 98, John Roth multiplied your shares by 9 times.
Do you still doubt it? Are you going to miss out again? Individual investors loaded up again. Pension plans loaded up. Nortel was nothing if not resilient. You couldn’t say the same for Lucent, who had spent much of the fourth quarter of 2000 stepping on a bunch of rakes.
They revised their earnings predictions twice, down from 24 to 18 cents per share, losing them almost $8 from the share price. Because of this CEO Richard McGinn was fired by the board. Then on November 21st they admitted to overstating sales by $125 million, lopping another 2 cents per share from their targets. Can you imagine that? You have thousands of accountants and you can’t even get your numbers right? Embarassing.
Since September 28th it had lost 56% of its value, dragging down Nortel and Cisco with it. During this same period Nortel was down 48%, and Cisco 36%. It was bad news for all telecom companies, but Lucent had fallen a long way since their record setting IPO.
Lucent had tried to grow too much too fast. All those companies it had gobbled up to compete with Nortel and Cisco were being ejected again. It spun off two major divisions as Avaya and Agere Systems. Nortel was smugly watching as Lucent tripped over its own feet. If this was still a race, it was now only between Nortel and Cisco.
On November 30th John Roth was given the honour of ringing the bell that signaled the start of the trading day on Wallstreet. Although it tends to be an honour given to American CEOs, that day it was Nortel’s 25th anniversary of being listed on Wallstreet. John Roth gave a speech later that day, and given the circumstances, he was well within his rights to be a little petty. "We grew 40% this year. Well grow 30-35% next year. A lot of people would like to have that problem.
Nortel does not have a problem." This infamous quote would haunt Nortel for years to come. By the end of December John Roth had been awarded Canadian newsmaker of the year, as well as Canadian CEO of the year. The stock recovered over the holidays thanks to an overall market rally in the new year, and it seemed that Paul Sagawa’s prophecy of disaster was oversold. But then…Cisco blinked.
In January CEO John Chambers had finally spoken into existence the words that every investor feared. “Is the economy slowing? Absolutely.” For Cisco the first quarter of 2001 was going to be “a little more challenging”. Cisco wasn’t ringing any alarm bells yet, but it was clear that they weren’t trying to promise the moon either. But on February 6th Cisco completely throws in the towel.
Cisco announced to investors that it would be earning 1 cent less per share than initially predicted. Their stock price is pummeled, and loses 20% in just a few days. By April they’ll be down by half. Meanwhile, in the background, Nortel had quietly cut 4000 jobs.
There is no official public statement. It’s not until January 10th that media hears rumours of job losses at Nortel, at which point Nortel unleashes a PR offensive. Any sales deal or new customer was broadcasted by the PR team. Didn’t matter how small the deal was, any good news was championed like a monumental saving grace.
To quote analyst Ross Healy “It was like the Hudson’s Bay company reporting the sale of every 31 inch television set”. There was so much good news pouring out of Nortel that the bad news had no room to breath. Then for good measure a Nortel spokesperson says the reporting on layoffs is exaggerated. You see they’re cutting jobs in slower divisions so they can hire more in faster growing divisions. If you think about it, by the end of the year we’ll have hired back the same number of people. Those aren’t lay-offs, that’s just strategic reallocation.
The spin seemed to work, and the markets rewarded Nortel by stopping their slide. 2001 Nortel was going to be meaner and leaner. Then some disturbing reports.
One internet company, ICG Communications, had just declared bankruptcy. Although there was no public record of any specific dollar amount deal with Nortel, Nortel had been listed as one of their "technological partners". Soon after Bookham Technologies announces reducing orders from Nortel. On its own a neutral statement. Maybe Nortel had found a better supplier? Finally, a major bit of good news, the same day Cisco had its bad news again.
Another acquisition. The first since the October crash. Nortel was buying a laser division for undersea fiber optics from JDSU.
$2 billion worth of shares. The deal is set to close on February 13th. The news that would come just two days later would trigger several class action lawsuits. Earlier in February, there had been a meeting in North Carolina. The CFO, Frank Dunn is there. He’s getting updates from division heads on their sales forecasts.
The first to speak was Greg Mumford. For the first time someone tells the truth to an executive. Sales are slowing down in the optical division.
Frank is momentarily shaken. Then he lets all the other business heads speak. Wireless? Going down.
Enterprise? Down. Everything is going down. Qwest, MCI, all of their customers had promised them a certain amount of business, but were now having to cancel orders because they lacked the money. Most of those deals had been done using vendor financing, Nortel promised deep discounts and loans in exchange for their business, but they couldn’t even pay for those.
Nortel had already recorded those as sales, even though they hadn’t been paid for yet. Nortel switches were sitting in warehouses, still on the palettes they were delivered on, but with nowhere to go. By some estimates these heavy duty fiber networks were supporting only 7-14% of their total capacity. There just wasn't enough internet activity to warrant the existing orders, much less any new ones. Nortel was about to drive off a cliff. Scratch that, they had run off the cliff months ago.
This was the moment where Wiley Coyote looks down and he realizes he's about to fall. Stunned silence in the board room. How had they missed this? How had no one seen this coming? In reality, lower level managers in Nortel had known about this problem for months. In San Diego, September 2000, Tim Dempsey, an HR exec, was running a leadership workshop. All of the managers are pulling him towards their table and begging him to listen. “You gotta tell John.”
“Tell John what exactly?” “The marketing numbers aren’t real.” “What’s fake exactly?” “Peel the layers and you’ll see that the assumptions are that end-users will buy networks from each of our customers. End-users only need one network each.
All the numbers are inflated”. These warnings never made it to John. Instead they were suffocated by the rigid bureaucracy of the management hierarchy. John Roth had surrounding himself and stuffed the board with yes-men. While he was busy telling investors what they wanted to hear, his own executives were doing the same to him.
Dave House, the former CEO of Bay Networks, only stuck around at Nortel for about a year before leaving. But after just 6 weeks, he shared with Tim Dempsey his opinion on the rot that infected Nortel. “I have never seen a bigger group of liars in my life. I am astounded that you don’t tell each other the truth. There’s a culture here to lie to each other to protect your turf, to protect your ego, to protect your business, to protect your customer relationships, to protect what…I don’t know. But you don’t tell each other the truth.”
In this moment, Frank Dunn doesn’t understand all of this. He just knows he has to make phone call. John Roth is not in the building, he’s not even on the same continent. John Roth would later describe his shock at the news as comparable to when he first heard about the attack on the World trade center later that year. A press release was being drafted, and it would go public in a little over a week.
On February 8th Nortel’s CTO William Hawe abruptly leaves, cashing in his stock options, although mostly at a loss. He sees the writing on the wall. Soon, Don Smith, President of Optical Internet Solutions, also leaves. Nortel won’t publicly mention these departures until a week later. On February 15th, it seems like just another trading day on Wallstreet, and the regular trading days ends without incident at 4pm. Just minutes after the closing bell though, internet trading forums start going bezerk.
They’ve just been fucked. Nortel has just issued a press release, and they’ve just changed their forecast. Nortel was not going to hit its target. That much was clear. When Nortel missed their earnings by 1 cent per share last October, they lost 25% of their stock price in one day. When Cisco missed their earnings by 1 cent per share, the market slaughtered them.
And of course Lucent had their traumatic fall from grace when mistakes in their accounting meant they had to lop off 2 cents per share, and their stock was nearly cut in half. The question was where in this range will Nortel's correction be? Nortel’s original target was earnings of 16 cents per share. And this was their correction. [Horror music] They didn't just underperform, their projected gain had turned into a projected loss. The next day so many Nortel shares are dumped that it crashes the Toronto Stock Exchange several times.
Nortel is cut by 33%. $44 billion is just…gone. The Financial Times summed it up in just one sentence. “It’s a wonder there is any red ink left in Canada”.
"We've known for some time that job cuts were coming but we didn't know where. Now we do. Today Nortel Networks announced 950 more layoffs. in Canada.
750 right here in Ottawa." "Robert more than half Canada's 24,000 Nortel employees work here in the capital region. And tonight, most of them are in the dark." At first it starts slow.
Last November had small layoffs. Employees assumed it was just routine, the bottom 5 percent being cut loose. Nothing out of the ordinary. It was only fair. Now though rating systems began to emerge.
Everyone had to be ranked on a scale of 1 to 5. But there was no minimum threshold you could meet, no level of productivity that could save you. Someone had to be a number 1. Someone always had to be at the bottom.
And then the paranoia sets in. You don’t want to be a number 1, you need to set yourself apart. Maybe you’re the laser guy around the office.
That’s your thing. Before you probably would have taught the new guy the basics, get him up to speed. It would make your job easier.
But now that would make you replaceable. Disposable. That’s your thing. You need that to be your thing. Because hoarding knowledge is the only thing that’s going to save you from being a number 1. Initially Nortel had begun announcing layoffs based on location, but soon that stopped.
Instead of knowing up front, you simply had to wait and see. One man had packed up his things and moved from Vancouver to Ottawa for a job offer, only to find out it had been rescinded by the time he got there. Before the bubble Nortel had several divisions with like Extreme Voice, Extreme Data. If your group had Extreme in its name, it was almost guaranteed you were gone.
Nortel was riddled with bloat. The acquisition spree had been made hastily and without any concern for overlapping product lines. You might have 2, or even 3 competing teams whose products overlapped. Only one would ever make it to market.
Tim Dempsey recalls an HR exec bragging at a meeting that Nortel was world class at downsizing, like it was something to be proud of. That Cisco's refusal to downsize was a weakness. People would congregate in the bathrooms just to talk about who might be next.
Employees would avoid being at their desk out of fear of having the phone ring, of seeing their manager’s name show up on caller ID. One day you’d look in the calendar and see a huge meeting room booked by your manager and someone from HR you didn’t recognize. It would always be scheduled at a weird time of day. Security was always nearby in case someone didn’t take the news well.
Sometimes they wouldn’t even say your name aloud. They didn’t even afford you that dignity. Your name would be flashed onscreen in a PowerPoint, jammed in between a dozen other names. Sometimes the entire product team would be called into an auditorium, and you’d be told “if you didn’t attend an earlier meeting, you've unfortunately been let go”. Managers often knew days ahead of time.
Company rules forbid from giving advance warning to employees. Sometimes though they would break the rules in order to do the bare minimum, and tell people to start looking for jobs. For some, being fired was almost a relief, to have to continue on at Nortel not knowing if you’ll make it through the next week would be agonizing.
“Their whole life is in a stall pattern right now.” The culture was changing too. No more free snacks in meetings. Managers stopped buying rounds of beers at the pub. Something that used to be benign, getting Nortel to sponsor your charity golf team, was now being denied.
In March managers could no longer award bonuses outside of designated periods. All exceptions had to be run up to the President for approval. Every single business trip had to be approved by your boss’ boss’ boss. Company cell phone? Nope, give it back. At the very least, they bent the rules for the company softball league. Formers employees were allowed to keep playing.
The emptiness was pervasive. Massive parking lots, which used to take 5 whole minutes to walk across, now needed only one or two rows. Whole buildings were now ghost-towns. Entire floors were just empty. One of the few benefits of this emptiness was that Nortel would let laid-off employees use their old cubicles to job-hunt for an entire month.
One final kindness. And then 9/11 happened. The entire stock market tanked, and the already tough job market dried up even more. 60,000 people had been let go, and Nortel’s Canadians cousins were just collateral damage.
JDSU cut 50%, 16,000 jobs, and was moving its headquarters to San Jose. Newbridge had been bought out by French company Alcatel. Bookham’s CEO said that Nortel very nearly killed them. Corel, which had taken on Microsoft in the software space in a David vs Goliath matchup, had been pummeled into submission. The dream of Silicon Valley North felt like it was over. Nortel is ubiquitous here.
You could throw a stone in almost any office and you’d likely hit someone who used to work there. But there’s almost a missing decade. This is something I’ve observed first hand in my working life. You have my parent’s generation, still working in tech after surviving round after round of layoffs. And then you’ll see plenty people my age, new grads, interns, people still in school. Where did the middle go? Where are the youngest gen Xers and the oldest millennials? A Statistics Canada study many years later found that of the high tech workers laid off in this period, 4 out of 5 of them did not go back to tech. 2 in 5 of them left the city
altogether. Those who where laid off went in every direction. Some took a year off and spent time with family. Others immediately went back to search for jobs in an increasingly dire market. Those willing to gamble even more went and founded start-ups on the back of napkins while they commiserated at the local pub.
Others completely changed career paths. Some became photographers, contractors, farmers, others opened up cafes. Brian Beattie was laid off from Nortel, and later became a bus driver. He said that even carrying around up to 72 children wasn’t nearly as stressful as working as Nortel was.
Others, like Roxanne Mclaren, had to have a difficult conversations with their children, they would not be able to send them to college that year. When the layoffs started Roxanne said that “it was like a day full of deaths”. Neither of my parents worked for Nortel, but they had plenty of friends who did.
My dad worked with people close to retirement who had to completely reschedule their life after losing much of it on the stock market. Hundreds of thousands of dollars, gone in an instant. My family was very lucky, making ends meet was not something I ever had to consider as a kid.
Although my mom got laid off twice, my dad kept his job. I was too young to realize what had happened at the time, when my mom got laid off the 2nd time I was just happy that now she could come pick us up after school. 2001 to 2003 had been brutal, it had been agonizing, but it was not the end. Nortel, despite everything, had come out the other side. Canada’s industrial titan was only bruised, not broken. It just needed a good captain to get it back on course.
That was the question on everyone’s mind. Who was going to replace John Roth? "One slip is one too many." "I don't think I've had two days that were the same." "Everything changes by the minute." The stunning forecast reversal in February of 2001 initiated a single day loss of 33%, $44 billion in market cap completely gone.
The whole industry was undergoing a nuclear winter. Lucent’s stock had cratered by 99% from its peak, and had now fired two CEOs. Even the prestigious Bell Labs was embroiled in scandal, as one of its physicists was accused of faking dozens of Nobel-worthy research papers.
Cisco, the most resilient of the big three, was still down 86% from its peak. However it was Nortel’s blind arrogance as it entered the dark cloud of 2001 that made its fall from grace the most dramatic. Between its peak in July 2000 and its lowest point in October of 2002, Nortel’s stock had lost 99% of its value, $400 billion of market cap just gone, losing it the title of Canada’s most valuable company. It was now worth less than it was at the start of the 80s. In late 2002, the Toronto Stock Exchange would replace the TSE 300 index with one that was far less exploitable.
It’s place in the Canadian economy would never be the same. Two months after his disastrous forecast, John Roth announced his retirement. Or, more accurately, the announcement of the future announcement of his retirement.
Although you might assume the board was forcing him out, it was actually the opposite. John had always planned on leaving in 2001, he said as much when he was interviewed for the job. He wanted out before age 60.
John Roth, despite everything, was still somehow viewed as the most competent person to fix this mess. The board desperately needed John to stay because the truth is, the line of succession was in chaos. Reportedly John had taken his hands off the wheel sometime in summer 2000 to give his hand-picked successor some practice.
COO Clarence Chandran. Nortel had nearly lost Clarence in 96 when a local rival had tried to poach him for their CEO role. Nortel learned of this, and went into panic mode, promising Clarence a guaranteed track to CEO in 2001 after John Roth left, and he had been the heir apparent ever since. But now Chandran was leaving too.
Years ago he had suffered a stab wound during an attempted robbery. Although he had taken time off to heal, the old wound was flaring up again, and it was making his job impossible. When Roth learned that his protégé wouldn’t be able to replace him, he was furious.
Getting to sit in the CEO chair at Nortel may have seemed like a dream job in January, but by April it was a death sentence. Reading outside speculation from the time is fascinating, because all of it was completely off base. The Ottawa Citizen had a list of 6 possible successors both inside and outside Nortel. But Nortel’s board picked someone so out of left field that he didn’t even make it into a top 6 consideration.
Frank Dunn didn’t want to be CEO. He didn’t want the spotlight. He and Roth had risen through the ranks of Nortel together.
They joined around the same time, both of them attended McGill, and he’d been Roth’s CFO during the boom years. But he was hardly an inspiring choice. Even Red Wilson, the chairman of the board who picked him for the job, said that “the time for visionaries was over”. Industry analysts were even harsher on him.
“He’s not an engineer and he’s not a mastermind of strategy. He’s in there to stop the hemorrhaging and to make sure the company stays alive to fight another day. When you have a prolonged drought you want the neanderthal accountants running the thing, and that’s who you’ve got”. His assessment was not wrong. Nortel’s books were a mess. With their cashflow decimated in 2001, their strategy of ignoring goodwill no longer fooled investors.
It was estimated that nearly 1/3rd of the acquisitions Nortel had made were complete write offs. Some they sold off for rock bottom prices, but almost $12.4 billion dollars had gone right down the drain. On top of that it owed around $5 billion in severance, it had sold off nearly 20,000 square feet of real estate, it had to cancel thousands of customer contracts, and was now embroiled in dozens of class action lawsuits. Not to mention, the securities regulators in both the US and Canada were breathing down their neck, Worldcom, one of their biggest customers, had just gone bankrupt due to a fraud scandal. And Frank had mini crisis unfold just months into his new job.
His CFO, Terry Hungle, had been caught illegally transferring funds out his company 401k right before Nortel announced 5000 layoffs, and the stock dropped 16%. Insider trading. Hungle was forced to resign and Dunn now had to pull double duty as both CEO and CFO, having to personally sign off on Nortel’s books as it tried to recover from the brutal downsizing of the last 3 years. Frank seemed almost set up to fail. And yet…by the end of 2002 he had secured several high profile deals, including $1 billion with Verizon.
Despite the deep job losses, Nortel’s technical foundation was strong. It was still considered a world leader in optical network, and its iconic Meridian line of telephone switches remained the world’s best seller, with around 43 million in use. Nortel eventually regained the title of Canada’s most valuable company with a market cap of a meager but still impressive $50 billion. And in early 2003, the magic happened. Nortel posted its first profitable quarter since 1997. Despite all those who doubted him, saying that he was nothing more than a neanderthal accountant, he had brought Nortel back into the green.
It’s hard to look at this new peak as a recovery when your past history has distorted your sense of scale so much. But this…was a win. In February 2004, chairman Red Wilson will leave a drawing on Frank’s desk, thanking him for saving the company. And two months after that Red Wilson would fire Frank. The details of exactly what happened would remain murky for years.
In October of 2003 Nortel announced it would have to restate its finances for the previous 3 years. Financial restatements are not unheard of. Accountants make mistakes, it happens. But according to the board, this was not just a mistake.
Allegedly, Frank, his CFO, and his top accountant had orchestrated a fraud in order to trigger an executive bonus plan. They had allegedly inflated their losses over the past three years so that they could move numbers around. By moving the numbers around with just the right timing, they had made Q4 of 2002 into a loss, and Q1 of 2003 into a profit, which triggered $12.6 million in bonuses for the three of them. The board acted swiftly, firing all three of them. As you can imagine, this shattered customer faith in Nortel.
The stock price began to slide immediately, and the miraculous recovery was just a flash in the pan. The three men had become pariahs in the media, a lightning rod for the anger of laid off employees and pissed off investors. They’d remain in the media for years, as rumors of an impending criminal investigation loomed. The board meanwhile was desperate to restore customer trust, and hastily named a new CEO. They decided to name one of their own to the top job, but they didn’t exactly have a wealth of options. Ever since John Roth left the board had been lacking anyone with telecom experience.
He had maintained an iron grip on the board for years, and without him they were lost in the sauce. They had diplomats, former politicians, lawyers, bankers, execs from aerospace and big pharma. The eventual choice, and I’m not kidding, was former member of the US Joint Chiefs, retired admiral........Bill Owens. Yes.
Somehow, this is not the first time I’ve covered a topic where a retired US admiral is brought in to save a multi-billion dollar enterprise. I know that I’ve built up a metaphor here about massive sea-faring vessels, but even this is a little too on the nose for me. The logic at the time that he could leverage his connections in Washington to reel in some big contracts for Nortel, a plan that never truly paid off. Most of his short 18 months as CEO were spent making a big song and dance about how Nortel was instituting new ethics guidelines and forcing executives to pay back any bonuses they had earned the previous year. Despite all that he mostly served as a sponge for angry shareholders to yell at while the board looked for a more permanent CEO.
The rest of the C-suite was a meat grinder, a revolving door of talent that often stuck around for only months at a time. Nortel hired on two separate men named Gary, both of whom came from Cisco to serve as President and CTO. They stay around for just three months. Their shockingly abrupt departure came after Bill Owens shot down their plan for a deal with Nokia, a deal that would allow them to compete in Cisco’s territory.
Things came to a tense climax when Gary D suggested during a board meeting that Bill Owens and his CFO be replaced. Gary D was fired instead, and Gary K joined him in protest. The Gary’s were outspoken about just how rough Nortel’s prospects were. “Nortel is an industry laggard,” “and it doesn’t seem to know it.” “Nortel needed 50 employees to do what Cisco could do with 5”. But more dangerously, Nortel was spread out far too broadly.
The Gary’s said that Nortel was either 1st or 2nd place in a handful of sectors, the problem was that they were competing in nearly 30 sectors. Owens was replaced in late 2005 by Mike Zafirovski, also known as Mike Zee, or Mike Zed as we say up here. He seemed much more suited for the role, coming from Motorola.
The board must have seen a lot in him, as almost immediately Motorola sued them for $11.5 million because Mike had broken his non-compete clause. Mike Zed was a certified Six Sigma blackbelt, a business guru type who was once a Protégé of Jack Welch, the famous CEO of General Electric and author of the book “Winning”. From employees I spoke to, there was a general sense that Mike Z was trying to run Nortel like an appliance company.
He stuffed the board with his old General Electric buddies, and had a philosophy of “record and measure everything, and then do it faster”. Turn around times were cut down to the bone. You’d had 2 days to fix any given problem, regardless of complexity.
Engineers would often derisively say "We don’t make toasters." The whole culture had deteriorated. Your competition was no longer your equivalent at Cisco or Lucent, now it was the person sitting in the cubicle next to you.
Paranoia was rampant. Customer facing employees were beloved by customers, but those same employees would bad-mouth their managers or other departments. It’s hard to blame them. You would become jaded too after the 12th round of layoffs.
The old Nortel was known for telling customers what they needed, predicting the market 10 years ahead of time. Now it was the customers telling Nortel, build us exactly what we want, or we’ll find someone else. And while Nortel was missing out on lucrative contracts, board meetings were derailed by problems with Nortel’s accounting issues.
Even after firing Frank Dunn, Nortel had restated their finances 3 times in 3 years, and each time their stock price crumbled. Mistakes happen, but not this frequently, and on this scale. Mike Z estimated around $400 million had been spent just on external auditors. In 2006 Nortel settled two class action suits against it for $2.5 billion. Nortel had spent most of the 2000s shrinking. It was no longer the massive ship it was at the height of the dotcom boom.
Every wave in the larger economy risked swamping it. The safest strategy would be to pair up. That’s what the rest of the industry had done. Lucent had merged with Alcatel. Nokia had bought out Siemens.
And Cisco was back to gobbling down start ups. Nortel was willing to buy, it was willing to partner up, hell it would even sell its own assets for a bit of fast cash. But Nortel was a toxic commodity, the odd one out at the dance, and its time was up.
In September 2008, Lehman Brothers files for bankruptcy, signaling the beginning of what will become the biggest economic crash since the Great depression. Canada too slides into a recession. With millions losing their jobs, their houses, the demand for telecom equipment drops off a cliff. On January 15th 2009, Mike Z calls a board meeting. Nortel has an upcoming interest payment on its debts.
The interest payment is just $107 million. Not that much, since they has about $2.5 billion in cash reserves. Paying it should be no problem. Except most of that cash isn’t on hand. Most of it is held in international subsidiaries.
Only $176 million was in Canada. Suddenly that interest payment was most of their cash on hand. The board debates what to do for 2 hours before the chairman asked for them to vote.
Mike Z recalls thinking that the vote would split almost directly down the middle. He planned to vote against it. When Mike Z joined the company three years earlier he had declared “I never left anything in worse shape than I found it”. But his heart dropped in his chest. He had completely misread the room. Every director had voted yes.
Nortel was going to enter into chapter 11. Bankruptcy protection. They would survive the global recession by making cuts, selling assets, becoming more efficient, focused.
That was the plan, a plan signed off on by plenty of generously paid external consultants. One of those consultants, Terry Savage, had this to say: “We’ve never seen a company as well prepared for Chapter 11”. His assessment would turn out to be comically wrong. The day after they announced Chapter 11 Nortel’s stock fell by 79%. Nortel would be gone by the end of the year.
"Well Steve company officials are already quoted as saying that chapter 11 bankruptcy is the end of Nortel but rather the beginning of a new Nortel." "Sound like a dream come true? Well it's reality. And it can help your business." In hindsight, the decision to enter into chapter 11 is baffling, no matter how you spin it.
Unlike filing for Chapter 7, which is where you basically give up and liquidate all your assets, Chapter 11 is more like going into rehab. Your debt paymen