From CNBC
Nov 3 2000 12:15PM ET
Why Cisco Is A Bargain
By Pat Dorsey
Stocks Editor, Morningstar.com
Special to CNBC.com
Pop quiz: For $500, or what's behind Door Number Three, identify the date of
the following headline: "Shares of high-flying computer-networking companies
plunged dramatically Monday as investors bet that the frenzied expansion of
both the public Internet and private 'intranet' computer networks is finally
beginning to slow."
Nope, the date was not two days ago. (But thanks for playing!) In fact, this was
written in a major metropolitan newspaper way back in the Paleolithic era, circa
early 1997, when Wall Street was having one of its periodic freak-out sessions
about a slowdown in demand for networking gear. The word on the Street was
that companies just weren't going to spend as much moolah on all those
expensive routers and switches, and so the entire networking group fell off a
cliff. Even Cisco {CSCO} lost about a third of its value between late January and
mid-March.
Cisco Systems 5-year stock price
For a little perspective, Cisco was then trading at a split-adjusted $7 or so. So
much for slack networking-gear demand over the past three years.
What Wall Street's Worried About
The fright du jour is that telecom carriers will rein in their spending next year,
which has sparked a revaluation of just about every company that's ever taken a
WorldCom {WCOM} purchasing manager out to lunch. To me, this selloff
reached the height of irrationality this past Monday, when a Lehman Brothers
analyst lowered his price target on Cisco, plunging the entire group further into
the toilet. Now, the new target is about $60 or so, which would still be about
20% upside from Cisco's $50-ish share price. Last time I checked, 20% in a
year was nothing to complain about--and since Cisco's earnings will grow better
than 20% over the next year even in the most dire of scenarios, the $60 target
even assumes that the stock's price-to-earnings multiple will shrink even further.
But I digress, as we were speaking of the much-ballyhooed slowdown in
"capex," or spending in capital equipment by telecom carriers. Before we lose
too much sleep over this slowdown, however, let's get a few facts straight. First,
the fear is not that carriers will be spending less on gear next year than they did
this year. Rather, it's that they will be ratcheting back the rate of increase in
their spending, from about 30% in 1999-2000 to a bit over 20% in 2000-2001.
Now, slowing growth is not as nice a market environment as accelerating
growth, to be sure, but it's not the end of the world, either--especially when the
end result of the slowdown is a still-robust 20% growth rate. That's the first
thing to keep in your head when those all about you are losing theirs.
The second thing to remember is that telecom carriers always underestimate
the amount of money they're going to spend on their networks. As I mentioned
a few weeks ago, carriers don't like to spend money. It makes them unhappy. It
makes their shareholders even more unhappy. So, every fall, they say "Next
year, we're going to tighten our belts on the capex front and boost our bottom
line. Doesn't that sound great, Wall Street? Doesn't that make you want to rush
out and buy huge blocks of our stock?" Then, like clockwork, the next year
shows up, customers scream for new and better services, and the carriers
quietly write really big checks to the gearmakers.
If You Missed the First One….
Pop quiz number two: Capex growth by telecom carriers in 2000 will come in at
about 30%. Anybody want to guess what the carriers were projecting a year
ago in terms of capex growth? How about 20%? Maybe even a lowball 15%?
Nope--try 7% to 10%.
Whoops. Missed that one. And you wonder why I'm taking the dire predictions
of a capex drought with a grain of salt...
To be fair, this past year's spending was partially fueled by a very robust market
for equity and debt offerings, which helped carriers write those big checks with
slightly less-shaky hands. However, capital markets dry up and return to life
with surprising rapidity. As long as the long-term demand is there for
next-generation data services--and believe me, it's there-- the capital spigots will
open up again at some point in the near future. They simply have to, because
the current architecture of the Internet won't support the kinds of services and
traffic that businesses are demanding.
Speaking of architecture, let's get right to the third thing you need to remember
about capital spending by telecom carriers, which is that it's not one big
undiversified lump. The blanket statement that "capital spending by telecom
carriers" will grow by X% masks a huge range of growth rates among different
types of equipment. Next year, for example, spending on voice-related
equipment will probably decline dramatically at the same time that spending on
optical gear continues to increase in a big way. Industry gurus Ryan Hankin
Kent, for example, estimate that the global optical transport market will grow
36% in 2001, which is a lot faster than the 21% increase they see for the entire
market.
In short, the high-growth areas of the telecom-equipment market--optical,
high-speed Internet routers, and voice over Internet Protocol--are in fine shape.
Moreover, even if there is a temporary hiccup in spending by carriers because of
capital constraints, the long-term demand picture is still very bright. For those
of you who've been kicking yourself because you didn't buy Cisco, Nortel {NT}
and their ilk a while back, well, the entire group just went on sale. None of them
are cheap, but most of them are worth a long look--Nortel in particular, in my
humble opinion. |
