Barron's Online -- September 3, 2001
Follow-Up
Bad Connection
Analyst Susan Kalla expects more trouble for beleaguered telecom-equipment
makers
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Follow-Up: Dog Days
The collapse in telecom stocks over the past several months might tempt some bargain shoppers.
But not Susan Kalla. Last spring we dubbed her the Dr. Doom of the telecommunications industry
because she had the most pessimistic forecast of any analyst we'd heard ("Sell, She Said," March
12). While other analysts thought telco stocks that had fallen 50% or more from their peak levels
looked promising, Kalla warned investors that the shares had further to fall. Her theory: excess
capacity, falling transmission prices and too much debt would continue to plague the industry and
hurt stock prices.
Dr. Doom was dead on.
Then an analyst with BlueStone Capital Securities, Kalla had Underperform ratings on Level 3
Communications, WorldCom, Ciena, Juniper Networks and Sycamore Networks. The shares of all
five stocks have since declined dramatically. Level 3 shares, which were already down more than
80% from their all-time high of 131, have since lost another 83%. WorldCom is down 24%;
Sycamore fell 60%; Ciena gave up 74%; and Juniper dropped 75%.
Now an analyst with Friedman Billings Ramsey, Kalla doesn't sound any
cheerier. "We've been in a telecom recession for a year and we haven't seen
the bottom yet," she says. Telecom-equipment stocks could decline by a
third from their already-low levels as industry fundamentals erode through
2002. "This is not a V-shaped economy or a U. It's an A and we're on the
downward slope," she says.
Last week Kalla slapped Underperform ratings on Ciena, Juniper Networks
and Lucent Technologies, with target prices that are 27%-30% off current
prices. These shares will fall, she says, as their revenues fail to meet
expectations and multiples contract.
Kalla separates herself from the pack by
ignoring company guidance and canvassing the
industry to decide where demand really stands. She recently called 50
telecom-service providers to see how much they planned to spend on equipment, to determine how
revenues at telecom-equipment companies might fare. The results weren't pretty. All but one said
they would reduce capital spending over the next two years.
Says Kalla: "The customers are saying they are going to continue to ramp down capital spending,
while the equipment companies are saying they see the light at the end of the tunnel with capital
spending picking up in 2003."
That disconnect explains why Kalla sees equipment-company revenues coming in much lower than
the consensus. She expects the service providers to cut capital spending by 17% in 2001, 18% in
2002 and 9% in 2003. "Investors believe equipment revenues could reaccelerate to traditional levels
of growth of about 10%-15% per annum in 2003, following the lead of management guidance from
Ciena, Cisco and Lucent," she observes. "We believe equipment revenues could decline in 2003."
News from WorldCom last week bolstered Kalla's prognosis. Worldcom Group, the company's
data, Internet and business services unit, revealed plans to spend $5.5 billion next year on capital
expenditures. That's well below this year's budget of $7.5-$8 billion.
Industry players told Kalla that budgets have shrunk because networks are already complete.
Others said large projects were slashed to conserve cash. Spending at some companies shifted from
buying new equipment to maintaining and increasing the capacity of existing equipment. And then
there's the problem of excessive inventory sitting at resellers, being sold out of bankruptcy and
stocking the larders of the telecom-service providers. "The Baby Bells have told me they have
inventory on every shelf," says Kalla.
Many larger telecom-equipment companies' shares already trade at one times revenues, which is
normally considered a fair price. Kalla, however, believes revenue estimates will come down and so
will stock prices. Smaller companies, such as Ciena and Juniper, have a tougher road to travel.
Their stocks still trade at multiples of revenues, and the multiple and the revenues will contract over
time.
Ciena currently trades at 3.6 times Kalla's 2002 estimate of $1.6 billion in revenues, which is under
the consensus estimate of $1.8 billion. That multiple would contract to 2.5 times to get the stock to
Kalla's target. The same holds true for Juniper, which trades at 5.5 times Kalla's 2002 estimate of
$891 million, again well below the consensus estimate of $1.1 billion. She also expects Juniper's
multiple to shrink.
As for Lucent, Kalla believes that only the company's wireless business, which generates about
one-third of revenues, or $6 billion, is performing well. Lucent will either continue to sell off
non-core product lines or it could take more dramatic steps. "Current and former Lucent executives
say management is looking at all alternatives, including cutting the company into three big pieces and
selling them separately," she says. A Lucent spokesman declined to comment on split-up
speculation.
Either way, Kalla believes that the stock is worth only $5 a share, which is a far cry from the
company's boom-time high of 84.
Dr. Doom strikes again.
-- Jacqueline Doherty |
