Will Networkers Ever Regain Their Glory?
Why Cisco, Nortel, et al. aren't "growth stocks" anymore.
By Paul Kaihla, September 2001 Issue of Business2.0
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<<Few people fell as deeply in love with big optical networking stocks as Bob McWhirter, a portfolio manager in Toronto. He was one of Canada's biggest bulls on homegrown favorites Nortel Networks (NT) and JDS Uniphase (JDSU). At one point McWhirter had more than half of the $1 billion portfolio he managed for Canada's Royal Bank in the two stocks, and their performance made him a star. McWhirter has since switched investment houses and launched another high-tech fund. And guess what? It doesn't hold a single share of those old favorites. "I'm trying to find relative value in a declining world," he says, "and those stocks aren't delivering."
What they are delivering, along with other widely held networking infrastructure and equipment companies like Cisco (CSCO), Corning, and Lucent (LU), is a seeming death spiral of bad news. Company after company has announced it is slashing payroll, writing off worthless inventory, falling short of earnings goals, or, even worse, losing billions. Cisco, the gorilla of the sector, saw revenues for its third quarter of 2001 drop 30 percent from the prior quarter (that's after growth of about 15 percent a couple of quarters earlier). The kicker -- so far, anyway -- was Nortel's loss of $19.4 billion in the second quarter alone, largely due to write-downs on acquisitions made during the boom. Some of these stocks are more than 80 percent off their highs.
What happened? After all, it was just last year that optical networkers were thought to have an all-but-bulletproof business model. E-commerce outfits might spend themselves into oblivion on Super Bowl commercials, but the growth of the Internet was manifest destiny. The companies of the future would need bandwidth the way a sprinter needs oxygen, and telecom carriers from AT&T to tiny Teligent would sell it to them as fast as they could lay fiber-optic cables in the ground. Meanwhile, optical fiber manufacturers, like Corning and JDS Uniphase, and network equipment makers, like Nortel and Cisco -- dubbed the "plumbers" of the Internet buildout -- would grow fabulously wealthy feeding the Internet builders fat pipes and fast switches. In that scenario, Cisco's October 2000 price-earnings multiple of 150 seemed, well, almost prudent.
If only. It quickly became apparent that the appetite for bandwidth wasn't insatiable after all. Telecom carriers laid bandwidth until the market choked on it -- spending a total of $107 billion last year alone -- and then ran out of funding. More than 10 North American carriers, including Teligent, slid into bankruptcy over the past year, while others, such as Covad Communications and Rhythms NetConnections, teeter on the verge. Not surprisingly, the survivors are in no mood to buy more fiber from Corning or routers from Cisco. "It's pretty gloomy for equipment makers," says Scott Starbird, West Coast head of telecom investment banking for Bear Stearns. "They have fewer customers, and the incumbents don't have as much incentive to spend on equipment. I don't think any new networks will be built for a while."
At least the Internet equipment makers are cheap, right? The best answer is another question: Compared to what? The stocks used to be growth stocks -- priced in relation to confident expectations of ever-expanding cash flow and profits. But when all your customers are telecoms, and all telecoms are either bankrupt or shell-shocked, a rosy future seems less like a foregone conclusion. The surviving telecom carriers won't start spending again until their excess capacity has been worked off and their earnings start to recover. That won't be tomorrow. "I feel reasonably confident that we won't see an upturn in carrier spending on equipment for the next two years," says Sanford Bernstein analyst Paul Sagawa. "I'm reserving judgment on 2003, but it's certainly within the realm of possibility that it won't be particularly good either."
This kind of talk suggests that Cisco, JDS Uniphase, Lucent, and Nortel may never again command the valuations they reached last year. In fact, suggests Don Coxe, a manager for Chicago-based Harris Insight Funds, which oversees $15.5 billion, the plumbers of the Internet might have more in common than anyone thought with plumbers of more mundane provenance. "The networking companies have been exposed for what they are -- cyclical capital goods stocks," Coxe says. "They should have multiples equal to Caterpillar and Alcoa." Food for thought: In late July, Alcoa changed hands at a price of 15 times projected earnings for the next four quarters. A comparably valued Cisco would trade at 84 percent less than its price as of late July. Cheap? Probably not yet.>> |
