Sifting Through the Networking Ashes
The latest confirmation that sales of networking equipment have slowed in the first quarter comes from FORE Systems. The manufacturer of asynchronous transfer mode (ATM) and local area network (LAN) switches stated that it would book only $100 million to $103 million in revenues for the quarter, a meager 35% increase over last year. Earnings per share will only be $0.09 to $0.10, down from last year's $0.11. These revenues are a drop from last quarter's $112.6 million in sales and $0.16 per share in profit, a very disappointing performance for a stock that has been among the favorites of momentum investors for more than two years.
The slowdown in FORE is just the latest sign of a slowdown in first quarter sales for all networking companies, with names like 3COM (Nasdaq: COMS) and CISCO SYSTEMS (Nasdaq: CSCO) either making full-blown profit warnings or public statements emphasizing that business was weak in certain geographical regions and among certain types of buyers. A big picture of growing weakness across the board has now developed, raising questions about how much networking companies will grow going forward. While the implosion of MADGE NETWORKS (Nasdaq: MADGF) and BAY NETWORKS (NYSE: BAY) due to a problematic merger and bad product transitions respectively were once viewed as company-specific, the more pessimistic are alleging that there is a larger pattern. Bay's turmoil has been extended beyond just last year's chaos -- the company has warned that comparisons will be terrible for the next few quarters as it attempts to rebuild its business -- so terrible that insiders dumped more than 2.2 million shares on the open market in January and February.
If the signs of sales slowing weren't enough, the merger of a number of high-profile companies have complicated the competitive picture. The Ascend-Cascade deal is only the latest in a slew of networking mergers that have been engineered to make the companies bigger and more competitive. The combination of Ascend's wide-area network (WAN) and remote access gear combined with Cascade's carrier-class ATM switches allows the company to provide end-to-end WAN solutions -- a distinction previously held by CISCO SYSTEMS (Nasdaq: CSCO) after its purchase of Stratacom. Unfortunately, the market was not sanguine about the Ascend merger, pasting the stock for $11 1/4 to $40 3/4 yesterday. Accompanying the news of the merger was Cascade's profit warning. The company stated it would only book $90 million in revenues compared to $110 million last quarter, confirming fears raised when the company last reported earnings that sales momentum was slowing.
A few weeks back, 3COM (Nasdaq: COMS) and U.S. ROBOTICS (Nasdaq: USRX) decided to tie the knot in a merger that has analysts and investors split on whether or not it was a strategically sound move. At the very least, it exacerbates the confusion and tension over the ongoing progression of networking technology. Although Cisco has historically been able to acquire seven or so small companies a year without blinking, the record for networking mergers otherwise is quite mixed. Bay Networks, the product of a merger between Wellfleet and Synoptics, had executives focusing on putting two companies together when they probably should have been pushing their research and development teams to work harder. With 3Com and Ascend now both engaged in fairly substantial mergers, many investors are worried that management focusing on making the mergers work may lose sight of the road ahead -- particularly when 3Com and Cascade have both preannounced terrible earnings before entering into pretty huge deals.
Although Cisco has not announced a bad quarter and is not involved in a huge merger, the leader in networking technology has actually been dogged by questions about technology. Cisco's mainstay routers are being challenged by a new technology called IP switching, pioneered by upstart Ipsilon. Although Cisco is releasing what it calls the Big Fast Router (BFR) to compete with the promise of IP switching using a new technology called tag switching, some investors are worried. Add to this Ascend's entry into the router market with the GRF router that uses technology it grabbed with its Netstar acquisition and you can see why some might be worried about Cisco's health, even if they are paradoxically fretting about the health of Cisco's competitors. For its part, Cisco expects the industry to maintain its 30% to 50% annual growth pace, and the company's goal is to grow at or above that pace, according to Chief Executive John Chambers. Chambers also confirmed that demand for corporate networking gear is down in an offhand way, stating "Customers insist upon receiving products quicker so Cisco has reduced its manufacturing lead times to one to three weeks from eight to 12."
Widespread weakness in corporate demand for networking gear, confusing mergers, and the ongoing march of networking technology to new standards are all haunting networking shares at the moment. The once-invincible stocks are now showing that they have vulnerable underbellies after all. Investors are scared and are reacting as such. Momentum players are clearing out of the stocks, leaving broken husks behind. Companies are doing stock deals with shares down 33% to 50% from their highs, causing some to question whether or not management really believed the stock was ever worth that much to begin with. Growth is obviously slowing, but it is going from low triple digits to middling double digits -- hardly disastrous.
Investors are cautioned to remember that the real measure for risk is the valuation at which you purchase a stock, not how volatile it is. Purchasing quality networking shares when all seems darkest and waiting a few years should provide the same kind of returns for investors that buying quality semiconductor and semiconductor equipment shares in mid-1996 provided. Keep in mind that those buying semiconductor-related stocks in mid-1996 had a few more months of terror to work through before the soundness of their capital allocation was revealed. Investors have been complaining for years that these stocks were too overvalued to purchase, even though they
wanted to buy. Now that the valuations are falling, they are scampering the other way. Individual investors need to decide whether they are running with the herd or whether they want to stalk their preferred prey on their own schedule, not one supplied by others. |
