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(Nokia stated this during their recent analyst conference. The key word is "50% less to operate" than GSM. Qualcomm speaks in terms of comparative operational costs as well, but few talk in terms of "build" costs (it is bunched in with "operational costs"). Anyway, build costs amortized over time with a 50% less operational cost scheme per user adds less than 8% per user over a any five year period).
Jubak's Journal
8 stocks likely to pop in the telecom squeeze
Given the telecom-spending worries, companies that will profit in the sector are likely to be the same ones that can rein in costs for the service providers. You may want to dial in on equipment makers like Vitesse Semiconductor and Corvis.
By Jim Jubak
Any time a CEO is willing to get up in front of a room of analysts and say that the market is wrong about his stock, I think it's worth paying attention.
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And that's just what Applied Micro Circuits (AMCC, news, msgs) CEO Dave Rickey did during his presentation at the American Electronics Association's technology conference on Nov. 7. That morning, his company's stock had been savaged by analyst downgrades of any communications chip company doing business with Cisco Systems (CSCO, news, msgs). Cisco had announced the previous afternoon that it had been building inventories to prevent component shortages, and analysts had logically concluded that the company would cut future orders to work down its backlog. By the time Rickey opened his mouth to speak, Applied Micro Circuits stock was down more than 10%.
But did Rickey lower his rather ambitious forecast of 20% sequential growth for the December 2000 quarter? Nope, not a single percentage point. Admit to order delays? Not seeing any, Rickey said. Sensing even a smidge of customer nervousness? Not a lick.
Either I'm in denial, Rickey summed up, and business is really falling apart due to the clear slowdown in telecommunications-equipment spending reported by Lucent Technologies (LU, news, msgs), Nortel Networks (NT, news, msgs) and Cisco Systems, or there's a huge shift going on in what telecommunications service providers are spending their dollars on. Companies are cutting their spending on older gear -- the kind they've already installed in their current networks -- and actually increasing their spending on the next generation of equipment that promises lower costs and higher performance, he said.
That possibility makes sense to me, because it fits in so well with the logic of the pinch on telecommunications service providers that I outlined in my last column, "Debt woes reach out and squeeze telecom sector." And if that's so, the recent indiscriminate sell-off in communications chip makers and the telecommunications equipment builders who buy from them is a magnificent opportunity to buy the winners in this sector at a massive discount from their standard, outrageous prices.
That is, if you can separate the winners from the losers. The best way to do that, I think, is to take the logic of the capital-spending squeeze that I wrote about in my last column one step further. Here's what I mean by that.
Logical winners
With the cost of capital up and revenue from voice and long distance down -- and with price wars threatening to eat into profits from wireless and business services, too -- the CEOs at telecom service companies such as AT&T (T, news, msgs), WorldCom (WCOM, news, msgs) and Sprint (FON, news, msgs) would love to reduce spending on new networks, switches, access concentrators and the like. Newcomers like Global Crossing (GX, news, msgs) and Qwest Communications (Q, news, msgs) would equally love to get out of the construction business and settle down to bringing in revenue.
But these CEOs know that they can't simply stop spending on their networks. Any company that does so risks falling hopelessly behind its competitors. A new generation of equipment promises to drive down the costs of running a network and delivering services to customers. Skimp too much and a competitor could gain a cost advantage that lets him undercut your prices and still make a larger profit than you do. Fail to upgrade your network and your company won't be able to offer the snazzy new services that competitors are rolling out and that could bring in the incremental new revenue that you need. Damned to paying more for capital if you do -- and double-damned to the real possibility of losing the war to competitors if you don't.
Stuck between this rock and that hard place, companies are trying to get more bang for their buck. They will certainly try to reduce spending. Next-generation provider Williams Communications Group (WCG, news, msgs), for example, will trim spending by $300 million to $400 million in the fourth quarter of 2000.
But within their capital budgets, companies also will try to shift spending. Projects that promise the biggest savings in operating costs will get funded, but marginal upgrades won't. New technology that enables future revenue streams remains a high priority, but investments in legacy technology are likely to feel the budget-cutter's knife. And any technology or product that will yield a fast return on investment stands a very good chance of getting a green flag even while overall spending is reduced.
Nokia (NOK, news, msgs) laid out exactly this scenario for Wall Street analysts in a recent conference call about the new, third-generation wireless systems, called 3G, that will be built over the next four to 10 years. The cost isn't insignificant -- Motorola (MOT, news, msgs) estimates that wireless carriers will spend $200 billion on third-generation systems over the next four years.
Despite the squeeze on telecom service providers, Nokia said that these companies will make that investment in third-generation equipment for several reasons:
First, the cost savings are so huge companies can't afford not to. Any company that doesn't invest won't be able to compete for very long. Nokia estimates that it would cost an established wireless operator about 50% less to operate a new third generation W-CDMA (wideband code division multiple access) system than their current system using the GSM (global system for mobile communications) standard that dominates Europe.
Second, the investment will enable wireless companies to offer new revenue-generating services. Third-generation networks will make it possible to deliver such products as wireless Internet access, instant text messaging and customized alerts at higher speeds and at lower costs.
Third, the payback can begin almost immediately. Nokia believes that third-generation systems are so efficient that some wireless carriers will be able to lease out some of the unused portions of the radio spectrum that they acquired when they won their original 3G lease, allowing them to recoup a portion of their costs.
From this example, and from my more general scenario, I think we can build a general picture of what kind of stock we want to buy in this sector.
8 potential telecom buys
The company should be making products that lower the operating costs of telecom service providers and network operators, or it should be making products that enable telecom service providers to offer new revenue-generating services. And the faster these products save money or increase revenue, the better.
I've got four equipment sectors -- and some specific stocks -- that I think fit that bill.
Higher capacity optical networking. Optical networking products in general fit my scenario pretty well since optical networks are cheaper to operate than copper networks. But once a company has gone optical, the next level of cost savings comes from loading more and more traffic onto the existing fiber. The current technology for doing that is called dense wave division multiplexing and companies such as Lucent and CIENA (CIEN, news, msgs) are busy leapfrogging each other in the race to put more circuits onto a single beam of light. Cramming more traffic onto fiber requires more-sophisticated and faster switches, and traffic-management devices loaded with silicon. Two chip makers at the forefront of making these higher speeds possible are Vitesse Semiconductor (VTSS, news, msgs) and Applied Micro Circuits.
All-optical optical switching. One huge inefficiency in any optical network is the need to change the information-carrying signals from light to electrons for routing and switching, and then back to light again for further transmission. A new generation of electro-optical switches from Cisco Systems and others promises to improve the situation. But the big leap is to the all-optical switches currently being sampled by Corvis (CORV, news, msgs).
Third-generation wireless. I've outlined the case for spending money on building a third-generation network, so I won't repeat that here. The two names to watch here are Ericsson (ERICY, news, msgs), the No. 1 global player in the wireless network infrastructure-equipment market and Nokia, currently a distant No. 4. Nokia is planning to use its strength in the handset market to sell more network equipment.
Revenue-generating platform builders. That's a mouthful, I know. I'm talking about companies such as Sonus Networks (SONS, news, msgs), which makes gear that translates voice signals into packets that can travel on the Internet, so that an Internet service provider can offer voice telephone service to its customers. Another example would be Tut Systems (TUTS, news, msgs), which just introduced a new platform, the IntelliPOP, that lets a telecom service company provide an array of broadband services from a single platform to all the residents of an apartment building or other high-density location.
These are the kinds of telecommunications equipment companies and stocks that I'd be looking for during the current squeeze on the sector. Some of them are now trading a long way off their 52-week highs. On Nov. 8, after the pounding following Cisco's inventory warning, Applied Micro Circuits was trading 40% below its high. That actually looks good when you compare it to the damage done to Ericsson this year -- that stock is 50% off its 52-week high. And both stocks have performed far better than Lucent Technologies, which is down about 75% from its high.
I wouldn't buy any stock in this sector -- or indeed in this market -- just because it's cheaper than it once was, however. This year, that strategy has just been an invitation to further losses. Multiples, otherwise known as price-to-earnings ratios, have come down hard across the entire technology sector more than once this year, and are quite capable of doing it again.
Jubak's Archive
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Recent Jubak articles:
• Debt woes reach out and squeeze telecom sector, 11/10/00
• Avoiding the curse of the new president: recession, 11/3/00
• Resist the home-run temptation, 10/31/00
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The investor inclined toward technical analysis would advise waiting on any stock until you see evidence of a sustained upward trend. I think that's sound advice, but tough to act on in a market such as this one that's seen more than one "sustained" rally turn into a precipitous decline. Remember the joy of August and the pain that followed in September?
In this market, I think it's worth putting fundamental analysis and technical analysis to work side by side. I know it's difficult to figure out what any stock is worth right now, but I think it's important to try. In my next column I'm going to see what the fundamentals can tell us about reasonable valuations for Applied Micro Circuits, Ericsson and Lucent Technologies.
Update: New Developments on Past Columns
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Find stocks built for speed -- and acceleration
Nvidia (NVDA, news, msgs) announced a blowout quarter on Nov. 9, including earnings of 35 cents a share, 3 cents above analyst expectations and 133% above earnings per share in the same quarter a year earlier. Revenue climbed by 104%. And the stock dropped anyway on fears of slower PC growth. Certainly, I understand why lower revenue estimates from Dell Computer (DELL, news, msgs) for 2002 (the company dropped its projections from a range of 20% to 25% growth to a straight 20%) would hurt any stock with exposure to the PC market. But I believe this quarter's results show that Nvidia's future growth isn't dependent on overall demand for PCs. First, the company continued to pick up market share in the quarter. Nvidia passed ATI Technologies (ATYT, news, msgs) to take over the No. 1 spot in the market for desktop 3D graphics processors, and it picked up another 8 percentage points to 24% of the retail market. In fiscal 2002, new or recently entered markets in laptops, workstations and game consoles should add up to 25% or more of revenue. In recognition of the company's fundamental strength, I'm raising my target price to $100 from the previous $98. But given the very tough market for technology stocks, I'm stretching out my deadline to October 2001 from December 2000. (Full disclosure: I recently purchased shares of Nvidia for my personal account.)
Catch profits by following telecom dollars
Cable and Wireless (CWP, news, msgs) continues to build the value of its overseas franchise. On Oct. 30, the company announced that it would spend about $1.4 billion to build an optical fiber network in Japan that will connect 80 cities in all of the country's prefectures. The build-out will include metropolitan networks in Tokyo and Osaka. I think this is an important move given repeated studies showing that Internet and data traffic in Japan is forecast to grow by 40% a year over the next five years. Of course, none of this is likely to move the stock anytime soon, which has been pounded by woes in the telecommunications sector. Investors are going to have to be patient with this one; I'm stretching out my $70 target price from December 2000 to October 2001.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Applied Micro Circuits, Cable and Wireless, Cisco Systems, Global Crossing, Nokia, Nortel Networks, Nvidia and Sprint. |
