Good article on downside of telecom equipment makers. High potential reward virtually always comes with high risk.
Internet & Technology
Friday, October 5, 2001
Few Big Spenders In Telecom Gear
Networks stay conservative in buying new equipment; manufacturers crimped
By Mike Angell
Investor's Business Daily
The telecom gear industry keeps getting bleaker as customers cut spending and vendors warn about weak earnings. Next year - and maybe even 2003 - doesn’t look much better.
Nortel Networks Corp.’s (NT) recent earnings warning, its fourth this year, shows that telecom gear spending hasn’t reached bottom. The company said it couldn’t estimate future sales.
And Corning Inc. (GLW), which makes fiber-optic lines, said Wednesday it will shutter most of its optical cable manufacturing plants indefinitely.
The bad news probably isn’t over, analysts say. Telecom customers could clamp down further on spending.
“There’s a chance of more cuts ahead,” said Friedman, Billings, Ramsey & Co. analyst Susan Kalla. “Some major networks have yet to announce their plans.”
Analysts forecast a 20% drop in spending from this year’s levels.
ABN Amro estimates 2002 U.S. telecom gear spending at $61.9 billion, down from $84.8 billion this year. Earlier, it forecast a slight 2002 rise to $89 billion.
“The companies that are exposed to North America are at the greatest risk,” said ABN Amro analyst Ken Leon.
Lehman Bros. says U.S. spending on networks will reach $72.7 billion in 2002. That’s a 21% fall from 2001.
Friedman, Billings, Ramsey & Co. says 2002 worldwide spending will be $91.8 billion, 18% less than this year. For 2003, Kalla expects another 11% drop to $82 billion.
More Pessimistic
Kalla is growing more bearish on telecom. She says she may lower her estimates further. Current forecasts are “too optimistic,” Kalla said. “You have accelerating bankruptcies among smaller service providers, much more radical cutbacks by big players and rapidly deteriorating prices for service.”
A series of earnings warnings reflect those cuts in spending. Nortel sees its third-quarter sales at $3.5 billion. That was the low end of Wall Street estimates. It expects to lose $3.6 billion, or $1.13 a share.
Broadband equipment maker Redback Networks Inc. (RBAK) said third-quarter sales will range from $35 million to $40 million. That’s a 35% fall from earlier estimates.
Third-quarter sales at optical gear maker ONI Systems Corp. (ONIS) will be $50 million, 38% lower than it previously guided. Fourth-quarter sales will be flat. The sales drop also pushed ONI further away from break-even.
WorldCom Inc. (WCOM) and Qwest Communications International Inc. (Q) were the first to cut spending plans. Qwest cut 2002 spending from $7.5 billion to $5.5 billion. WorldCom cut projected 2002 spending to $5.5 billion from an earlier $8.5 billion.
Changes to future spending plans could come in October and November as networks announce earnings.
Verizon Communications Inc. (VZ) and Sprint Corp. (FON) may update spending plans this month. AT&T Corp. (T) and BellSouth Corp. (BLS) should provide spending plans in January.
No sector has been spared. The spending weakness first hit long-distance fiber-optic gear and voice switches. Most of Nortel’s sales come from those two areas.
Niche players like Ciena Corp. (CIEN) and Juniper Networks Inc. (JNPR) are also hurting. “Best-of-breed” technology was once considered immune to spending downturns. Not anymore, Kalla says.
“The markets that Juniper and Ciena sell into are oversaturated,” Kalla said. “The markets they are selling into are overbuilt.”
Equipment makers hoped sales of fiber-optic gear for city networks would weather the storm. But the so-called “metro market” is turning into a bust, too.
“There are 200 vendors looking to sell metro equipment, but there are only eight customers,” Kalla said.
Start-up gear makers also face tough times. Last year, networks let start-ups test new technology in their labs, Kalla says. But “in a downturn, that becomes a very expensive undertaking,” she said. “They’ve rolled up the welcome mat. There’s an anti-best-of-breed phenomenon.”
China was another bright spot in spending. But it, too, is dimming.
The country’s biggest network, China Telecom, is undergoing a restructuring as it becomes privatized. Lehman analyst Tim Luke expects China Telecom to cut spending to $9 billion from $12 billion. Nortel says sales to Asia have fallen from earlier quarters.
The various warnings have analysts lowering their estimates on Cisco Systems Inc. (CSCO) ABN Amro dropped estimates for Cisco’s fiscal first-quarter sales to $3.6 billion from $4.2 billion.
Analysts polled by First Call/Thomson Financial say the company will earn 2 cents a share. Cisco said on Wednesday that it expected to meet analyst estimates.
Sales estimates for full fiscal 2002 were lowered to $16.3 billion from an earlier $18.7 billion estimate. The full-year earnings outlook was cut to 8 cents a share from 15 cents a share.
Telecom Bubble
The spending cuts come after a huge three-year buildup in spending. “It’s not dissimilar to the dot-com bubble,” Kalla said. “You have a bunch of overleveraged companies competing in the same business.”
Private and public investors pumped $160 billion into new networks in 2000, Kalla says. The result is overcapacity. There are now 11 long-distance companies. And that number doesn’t include AT&T, Sprint and WorldCom.
Prices of long-distance voice service — the networks’ bread and butter — are falling 50%. Normally, they fall 5%, Kalla says. There are also 300 new regional phone and data companies. They haven’t had much success against established networks like Verizon.
Bankruptcies of telecom networks flooded the market with used equipment. Gear makers are having to try and sell new products when networks can easily buy used.
The downturn means a buyer’s market for technology. Epik Communications Inc. originally planned to spend $400 million building its fiber-optic network. It will now spend about $325 million.
Epik Chief Executive John McClellan says prices on some gear has fallen 50%.
He says companies are more eager to do deals. Previously, one salesperson might have visited his office. Now entire sales teams arrive. Even CEOs call to clinch deals. “There’s certainly a lot more attention paid to our account,” McClellan said.
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