If there ever was a company who fully represented the stock market during the early 2000’s, Nortel would be it. From being one of the biggest benefactors to the dot com boom, to one of the biggest crashers, to accounting scandals, to failed restructuring and bankruptcy… the Nortel bankruptcy encompassed all of this and more.
The Dot Com Bubble
So how did this all start? The wild ride known as the Nortel bankruptcy was thrust into the public eye during the late 90’s. Internet stocks were all the rage, as were any companies that serviced these stocks or were seen to be a part of the new technological revolution. Network and telecommunication stocks like Nortel were among the most popular during this time.
Investors expected computer networking to take over the world of business like never before. The technology itself was seeing exponential growth in efficiency which led to the same kind of growth in profits, or at least it should’ve. The general public thought this trend would never end.
The stock market reacted to all of this optimism accordingly. With expectations through the roof, stock prices followed. Companies during this time period didn’t even need to be turning a profit, as investors excused traditional valuation metrics as old and obsolete.
People saw the new technology as being part of a new world. They thought that they had entered a new era of investing, one where all of the old rules didn’t apply.
Economic theories such as the “greater fool theory” began to be more accepted and utilized, though it didn’t have a name at the time. The idea behind the greater fool theory is that it doesn’t matter at which price you buy a stock, because as long as the stock price keeps going up, there will always be a greater fool who is willing to buy it from you.
This strategy worked for investors during much of the late 1990’s. It created one of the biggest stock market booms that we had ever seen, and pushed stocks like Nortel up to towering highs. Nortel’s market capitalization got so high at one point that it was bigger than one third of the entire Toronto Stock Exchange index.
Nortel wasn’t even making money during this time, people just expected that profits had to materialize in the new technological world.
As you can imagine, it didn’t end like these investors expected. Once the dot com bubble popped, stocks that were driven up by the optimism got equally pummeled on the way down. Some, even most, didn’t survive through the crash. Negative earnings and other factors got the best of these stocks and bankrupted them.
However, Nortel survived. The stock price took an absolute beating, but the company was able to hang around until 2009. In the meantime, it was able to pick up the pieces from the dot com debacle and even rebound into profitability through major restructuring with new management.
Frank Dunn, the CEO at the time, was credited for turning around the company and launching them from their dark years in the red into positive net earnings in 2003. Dunn and his management team were promptly rewarded with hefty bonuses.
The victory was short lived, as it was discovered that the company had been fudging their books and misallocating figures. Investigators finally found errors in excess of $3 billion just relating to revenue alone. The lofty executive bonuses had to be paid back, though only 10% or so could be recouped.
Nortel picked up new management, survived the accounting scandal, and continued to plod on through years of mediocrity until the housing crisis recession put the nail on their coffin.
It’s kind of a sad story. To see such a fall from greatness, followed by a slow and painful death. Even another restructuring in 2008 couldn’t save Nortel.
What was the problem? Was data networking just not that profitable? Or did management just continue to fail, no matter who was put in position?
Today’s High Flying Stocks
We have to look into the numbers to really find the answer. I think it was some combination of both, but I am just speculating. What we can learn from this is that there will be stocks who follow this same pattern again. Which stocks these will be nobody knows, but even as I write this there are several companies with low profitability and record high stock prices.
A company like Tesla continued to book annual earnings losses yet the stock kept rising higher and higher.
Companies like Netflix and Amazon continue to follow a straight line pattern upwards yet struggle with low profitability in relation to their share price.
These companies are undoubtedly leaders and innovators in their respective technological fields. Yet like Nortel learned, a claim to greatness means nothing if you don’t have the financials to back it up. No matter how high your stock price gets.
The Nortel bankruptcy story finally concluded with its filing on January 14, 2009. The once great telecommunications and data networking company, a leader since 1895, was dead. [click to continue…]