Telecom equipment giants rethink the value of vendor financing model

When the recent telecom boom was in full swing, equipment vendors had few qualms about lending money to customers to ensure that those clients kept buying their products. Now, with many clients either scaling back their purchasing or having gone out of business, the repayment of many of those loans is in serious jeopardy.

This state of affairs is causing vendors such as Nortel Networks Ltd. and Lucent Technologies Inc. to reduce their level of “vendor financing”, as the practice is commonly known. Some observers contend the strategy was an example of bone-headed strategizing.

“It was a period when big, smart companies blew off business fundamentals,” said Lawrence Surtees, an analyst with IDC Canada in Toronto. “Fifty years from now kids are going to be doing their MBAs, thinking, ‘What were these people thinking?'”

One Nortel customer that has had trouble holding up its end of the bargain is Leap Wireless International Inc. of San Diego. In March, the firm announced plans to amend deals with Nortel and other creditors. Leap wanted to increase the ratio of debt-to-earnings laid out in the agreements, so the firm could free up some cash and use it to boost business. And in April, Metromedia Fiber Network Inc., a network backbone builder from New York, said it had defaulted on a US$8.1-million interest payment to Nortel.

Surtees said vendor financing tends to attract “much more risky borrowers. At the end of 2000, the nightmare came true. The boom slammed into a wall, deficit, downturn, the money dried up. The customers started disappearing in droves leaving the equipment makers…on the hook.”

It’s bad news for the vendors now and it augers ill for their futures, said Ray Wheeler, partner with Grant Thornton LLP, a forensic accounting firm in Toronto.

“I’m a customer and I’m starting to have trouble paying the money I already owe. I’m not going to be able to buy from you further down the road; I’m not going to be able to upgrade – it really does turn into a snowball effect. That’s what everyone is having such a hard time evaluating: how serious is this?”

According to Mark Quigley, an analyst with Kanata, Ont.-based Yankee Group in Canada, most clients looking to Lucent, Nortel and other manufacturers to provide equipment should not be fazed by the vendor financing fiasco.

“The…community is interested in buying data networking and wireless equipment that delivers cost-effective, robust solutions that enhance their service offerings,” he said. In particular, “Nortel still has that reputation in the marketplace and I would suggest that it hasn’t been tainted by the financing.”

Manufacturers have cut back on vendor financing lately. According to a filing with the U.S. Securities and Exchange Commission, Nortel had US$2.1 billion in financed agreements left in 2001. Compare that to US$5.2 billion in 2000. (IDC Canada said Nortel had US$4.1 billion in vendor financing in 2000.)

Lucent, meanwhile, lists $US2.4 billion of financed deals on its books for 2001, said Frank Briamonte, a company spokesman. That’s down from US$7.5 billion in 2000, he explained. (IDC Canada said Lucent was on the hook for US$8.1 billion of financed deals in 2000).

As far as Lucent is concerned, vendor financing is a “limited resource,” nothing more, Briamonte said. Sure, Lucent used to sink a lot of money into lending, but times have changed.

“Two years ago there were a lot of CLECs on the scene,” he said. “A lot of them might have needed vendor financing to get their networks rolling. We’ve seen a change in the industry, as far as a lot of CLECs no longer being around. [Vendor financing] is definitely used more sparingly now.”

Briamonte said Lucent changed its outlook to match the situation. “We’re focusing more on the world’s largest service providers, our biggest customers.”

That’s not to say Lucent will ignore telecom newcomers or smaller companies in need of a helping hand. It’s just that there are fewer of such firms around these days and Lucent saw the writing on the wall.

“It doesn’t mean we’re never going to do business with a smaller company,” Briamonte said. “More of our business is focused on the larger companies, and the larger companies don’t need vendor financing.”

Even though Briamonte said Lucent has changed with the times, Surtees suggested that it’s too little, too late for some equipment makers. They should have seen the trouble coming much sooner than they did.

“The emperor’s got no clothes. For a large player not to have been exposed this way, it would have had to have an executive to say, ‘I don’t think this boom is going to last forever. Even if it lasts the year, I’m not going to dispense with fundamentals.’ But the boss and board are saying, ‘But your competitors are…’

“It would have taken someone with strong principals. They would have taken a hit on their shares, which is why they didn’t do it, but going forward, they would be much, much stronger.”