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Strategies & Market Trends : VOLTAIRE'S PORCH-MODERATED -- Ignore unavailable to you. Want to Upgrade?

To: SecularBull who wrote (7209)	10/11/2000 8:54:23 AM
From: Dealer	Read Replies (1) \| Respond to of 65232

<font color=green>The Internet Is Not Yet Finished By Pat Dorsey A strange thing happens just about every fall. Telecom carriers start hinting that maybe the growth rate of their spending on equipment will slow down in the coming year, everybody goes nuts, and the stocks of the telecom-equipment companies get poleaxed. Inevitably, the carriers wind up sheepishly admitting that well, yeah, they're going to wind up spending a lot more than they thought they would, and everything goes back to normal--until 10 months later, when it starts all over again. Just like death and taxes, as they say. We're currently in the midst of this annual cycle, which is why everyone from Cisco (Nasdaq: CSCO - news) to Sycamore (Nasdaq: SCMR - news) is watching their stocks get taken out and shot. To be fair, the entire communications-equipment crowd was trading at unsustainable levels a few months ago, so the sell-off wasn't totally unexpected--when stocks trade at 450 times next year's estimated earnings, it doesn't take a whole lot of bad news to send them lower. However, to think that this group of companies is going to run into a brick wall from a lack of demand is shortsighted, in my humble opinion. Denial Isn't Just a River in Egypt You see, there are a couple of reasons why telecom carriers generally underestimate their capital expenditures. For one thing, the thought of writing big checks to the gear manufacturers--and then paying employees to install the new gear--pains the carriers considerably, since the higher expenses squeeze profits in what's already a low- margin business. So, the carriers stay in denial as long as possible about how much gear they're really going to need to buy in the coming year. For another, carriers have real economic incentives to delay capital spending until the last possible minute. As I explained in a column several months ago, many carriers are only installing gear on an as- needed basis in an effort to stay as close to the edge of the demand curve as possible. There's no point in building out a ton of excess capacity now when gear twice as good will probably be rolled out in a year or so. Since carriers are only installing exactly what they need and no more, they tend to underestimate demand. The Prisoner's Dilemma Finally, we have a cutthroat competitive landscape, which produces what Paul Johnson of Robertson Stephens has elegantly likened to the famed prisoner's dilemma. If all carriers slow down their capital spending--and the rate at which new services are rolled out--then all the carriers are spending less money and no single carrier has a competitive advantage. (Customers are screaming bloody murder, of course, but we'll ignore them for the moment.) However, if just one carrier buys new equipment that either lowers its costs or enables it to add new services, that carrier gets a ton of new customers, enabling it to further distance itself from competitors by taking advantage of economies of scale. Since no carrier wants to be on the losing end of such a scenario, the optimal strategy for all carriers is to spend like crazy just to keep up. Needless to say, this scenario--along with the oft-overlooked fact that the demand for bandwidth is still at least tripling every year-- bodes well for companies that sell communications equipment. Who Wins and Who Loses So, the big-picture scenario looks pretty darn solid. Will there be some bumps along the way? Sure. Wall Street is a fickle creature, and the capital markets upon which the carriers rely can go through short- term droughts. Moreover, most of the communications-equipment crowd is still trading at nosebleed levels, despite the recent sell-off, which means that some could certainly fall further if Mr. Market's love affair with all that is tech cools more than it already has. But with the buildout of the global Internet only in its early stages, you've got to like the long-term prospects of firms that help speed and manage the flow of information. Even if capital-spending growth slows slightly next year, the demand is too strong and the competitive pressures are too great for carriers to do anything but spend like crazy over the next few years. o anything but spend like crazy over the next few years. Etc. Talk about timing. No sooner did I finish writing this column than Lucent [ticker LU] blew up after the close yesterday -- an occurrence which is becoming a rather disturbing habit for the company. Two things are worth noting about the blowup. First, I think you can expect some nice numbers from Nortel [ticker NT], since Lucent doesn't seem to be regaining a whit of share in high-end optical market. (It's always nice when your chief competitor can't get its act together.) Second, the earnings shortfall was caused by purely Lucent-specific reasons, rather than weak demand from carriers. In other words, the carriers are still spending -- just not on Lucent's gear, it seems. Finally, I think you can expect a management shakeup at Lucent sooner than later. With the possible exception of recently-hired CFO Deborah Hopkins, I think the current team has lost virtually all credibility with the Street. When that happens, it's time to clean house. Pat Dorsey can be reached at patrick_dorsey@morningstar.com.