Cutback Plague Descends Anew on Lucent, Cisco, Nortel
By Scott Moritz
Senior Writer
08/31/2001 09:04 AM EDT
It figures. The moment the big network-equipment companies start to get a handle on their problems, WorldCom (WCOM:Nasdaq - news - commentary) opens the gate on the next stampede of equipment-spending cuts.
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WorldCom on Wednesday became the latest cash-starved phone company to cut back on capital spending, saying it will spend $5.5 billion on new gear next year, 20% below previous projections and 44% less than last year's spending. But all the big U.S. phone companies, from local giants Verizon (VZ:NYSE - news - commentary) and SBC (SBC:NYSE - news - commentary) on down, are likely to deliver dramatically lower 2002 spending projections in coming weeks, analysts say. Though the belt-tightening is nothing new, the scale of the cutbacks -- 20% to 30% from current expectations -- indicates the industry is preparing for nothing less than a prolonged sales slump.
That means the pain has just begun for the likes of Lucent (LU:NYSE - news - commentary), Nortel (NT:NYSE - news - commentary) and Cisco (CSCO:Nasdaq - news - commentary), whose shares have plunged over the last year as white-hot growth gave way to torrents of red ink. These networkers, which for now are optimistically forecasting flat to slightly lower results next year, are likely to see their numbers drop drastically.
Having once soared with the highflying optical Internet builders of the future, network gearmakers are now grounded, tethered to plodding old-line outfits like Verizon, SBC and WorldCom. And now that the equipment makers have shrunk to as little as half of their former size, these latest austerity mandates by their core customers will test these networkers anew.
I'm in Tatters!
Judging by the disarray at WorldCom, one of the nation's better-regarded telcos, a rebound for the telecom-equipment sector appears far off in the future. The nation's No. 2 long-distance phone company is slightly ahead of the pack as it grapples with falling sales, a staggering debt load and plunging wholesale prices.
WorldCom in many ways exemplifies a phone-service industry in tatters. Even the near monopolistic regional Bells like Verizon are seeing sales drop in core areas such as new phone-line installations. The company, which has cut its 2001 equipment budget by $1 billion to $17 billion, is preparing dramatic cuts in capital spending, says a person familiar with the company. These cuts already have spread throughout the telecom-equipment food chain: Corning (GLW:NYSE - news - commentary) on Wednesday offered more alarming evidence of a deepening slump in spending. The optical-fiber and component maker said Wednesday it was firing an additional 1,000 workers (20% of the workforce), bringing its total to 8,000.
But while spending cuts wisely seek to balance the money going out with the money coming in, they also can undercut the service rollouts and upgrades that ultimately drive sales growth and improve network efficiency. Credit Suisse First Boston analyst Dan Reingold pointed out as much in a note to clients Thursday.
"In 18 years in this industry, we can't recall a capex cut of this magnitude that did not eventually negatively impact the top line," wrote Reingold, who rates WorldCom hold.
It's not clear how circular this process will be and whether today's cuts will beget future spending cuts. But there's more than spending at issue here.
Then the Locusts
Falling long-distance prices are the No. 1 plague on the phone-service industry, and despite claims by some companies that the condition is stabilizing, there's plenty of evidence to the contrary.
Fresh off a round of interviews with communication-service buyers at several large companies, Friedman Billing Ramsey analyst Susan Kalla says long-distance prices have fallen by 35% in six months. Businesses are declining to sign new service contracts for fear of getting locked into high prices, says Kalla.
One large East Coast pharmaceutical company recently was able to get WorldCom to cut its long-distance prices by at least 25%, to less than 3 cents per minute, says Kalla.
WorldCom insiders say the company's pricing structure is a shambles. One former senior sales manager with the wholesale business says efforts to hold pricing offers to profit-sustaining levels were abandoned.
"One week we were instructed to manage our pricing toward a given EBITDA number and the next we were told to go for revenue, regardless of cost," says the ex-manager.
A WorldCom spokesman says the wholesale business is now part of MCI, the consumer long-distance operation that trades as a separate tracking stock, and sales policies there are managed for cash performance, not necessarily for profit margins.
Other insiders tell equally discouraging tales.
Apparently, savvy customers have been soliciting competing bids for Web-hosting services from WorldCom and its data divisions, UUNet and Digex. "Since there is virtually no communication between the individual firms at the rep level, we all ended up competing against one another and lowering the final price substantially," says a WorldCom account manager who recently left the company.
WorldCom representatives say there no longer is any separation between UUNet and the WorldCom businesses, and add that the company is "working hand in hand with Digex to address the marketplace as efficiently as possible."
To be sure, WorldCom has been among the few telcos that hit financial targets in a difficult year. And given the success of its $12 billion bond offering in May, it's clear that scores of investors still are betting on its ultimate success.
But until WorldCom feels confident enough to resume investing in network expansion, its suppliers can look forward to a long dry spell.
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