Nortel rides spending turnaround
A near-casualty of the Internet bubble is poised to come out swinging as telcos go shopping for networking gear.
NEW YORK (Fortune) -- One of the ghosts of the Internet past is showing signs that it's back from the dead.
After cutting capital spending in the wake of the tech collapse in 2000, phone companies are buying gear again to develop new services, upgrade their wireless networks and catch up on maintenance of neglected systems.
Among the key beneficiaries of the emerging revival is Nortel (NT), a near casualty of the Internet bubble's burst.
On Thursday, JPMorgan analyst Ehud Gelblum upgraded Toronto-based Nortel to a buy from neutral after four years of taking a wait-and-see approach. Gelblum says in a research note that he found encouragement during Nortel's analyst day Wednesday. He cites solid demand for wireless gear and Nortel's recent win with Verizon (VZ, Fortune 500) on a big Ethernet switching contract as positive signs.
"We now have a much better feel for how the company hits 10% operating margin over the next 1-2 years, even with very modest revenue growth," Gelblum writes. Besides benefiting from an increase in telco spending, Nortel has worked hard on cutting costs and jettisoning disappointing businesses like its efforts in WiMax, a high-speed wireless technology.
There are favorable signs for Nortel, but not everyone is ready to pronounce the broken tech shop fixed.
"Nortel may see improving top line metrics and meaningful earnings growth," said RBC analyst Mark Sue in upgrading Nortel to "neutral" last month. But, he added, "Progress will not come without challenges and the company to date has been very inconsistent with its execution."
Judging by Nortel's stock price, Wall Street is starting to have a change of heart on Nortel. In the past month, Nortel shares have risen about 25%. The good cheer hasn't spread to gear peer Alcatel Lucent (ALU), which has seen its stock fall 12% in the same period.
Both equipment suppliers fell on hard times as their big telephone company customers merged and budgets shrunk over the past seven years. Nortel and Alcatel Lucent, along with Cisco (CSCO, Fortune 500), Ciena (CIEN) and Corning (GLW, Fortune 500), are the arms suppliers to the video war between phone and cable companies. But between 2001 and 2007, Nortel and Alcatel Lucent sat on the sidelines nursing their sickly businesses as their rivals profited from increased broadband demand. Though Nortel is starting to catch up, stale wireline gear and lost marketshare in wireless have not helped Alcatel Lucent get back in the race.
"There are pockets of strength in telco spending," says Sue in a subsequent interview Monday. "Most of this being driven by the growth in HD traffic as well as the proliferation of video across multiple networks." And while wireless networking remains challenging at the moment "the outlook is getting a little better," says Sue.
Alcatel Lucent has spent the better part of the past three years cutting staff and lowering its financial targets. The Paris telecom gearmaker continued that streak in April, delivering its fifth consecutive quarterly shortfall. If Alcatel Lucent is going get traction on its three-year turnaround effort, this might be the time.
"Assuming we aren't going into a severe recession, 2008 spending should be up a little bit," says Telecom Pragmatics analyst Sam Greenholtz, who recently finished a spending outlook report for clients. While the shift isn't going to be dramatic, it does mark a big reversal of a painful trend, says Greenholtz.
There will be another bump up in spending next year as telcos start pouring a little more money into their wireless networks, he adds.
"We are basically just now coming out of a depression era in telecom," says Greenholtz. 
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