Aside from my two discount brokerages, I also have an account at Prudential. I requested their most current analyst report on the networking sector and received the fax shortly afterwards. I don't have a scanner, nor do I know of any other way to copy the text for pasting here, so I will simply type it out in two parts -- so forgive any typos.
The following is the most up-to-date networking/telecom analysis available from Prudential, and covers a broad array of topics and impact of the Asian situation.
Style Pts.
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MKT: NETWORKING -- 11/19/97
TITLE: NETWORKING INDUSTRY
ANALYST: LUKE SZMCZAK
Asia currency turmoil could have a substantial impact, but it is still early to reach a conclusion.
Impacts in the developing Asian countries are likely to be greater than in the developed countries.
Asia has tended to be the fastest-growing region for most of our companies, although this growth is typically on a relatively small base of business. Generally the networking companies have a greater exposure in the developed markets, where penetration of data networking gear tends to still be well behind the U.S. For telecom equipment companies, while developed Asian markets are important, the exposure is greater in the developing markets, particularly China. Because the buildout of telecom infrastructure is as important as the construction of roads and bridges.
The impact of Asian devaluations depends upon how broad the damage becomes. With slow China growth appearing to be the biggest risk.
China has been the engine of growth for the telecom equipment companies in particular. While sales of central office switches continue in China, the market has flattened due largely to intense pricing pressure, with fiber optic transmission gear and cellular being the hot growth segments. Both are key technologies for the infrastructure of a developing country and as such we would expect buildouts of fiber transmission and cellular systems to continue, however slowing GDP growth suggests the potential for a slower growth rate of buildout, if for no other reason because of reduced access to capital. This was the case in 1995 for Ericsson, when Mexican sales became sluggish following the December 1994 Mexican devaluation.
The exposure to Asia varies widely among our companies.
Motorola's early move into China is reflected in the high percentage of its business from China (11%) and Asia (30%). As noted in the chart that follows, because of the difference in the mix of sales among our companies, it is somewhat misleading to focus just on percent of sales from Asia, particularly because the growth rate in Asia varies widely among companies. For instance, Motorola hasn't seen substantial growth coming from Asia, despite its high exposure to Asia. Beyond the issues in Asia, much of the risk lies in 1998, and we do not expect noticeable impact on December quarter results for stocks in our universe.
[see chart on next post]
When and how actual impacts will be felt is nearly impossible to predict, but we see the impacts arising from several different factors. Our comments below reflect some of the potential impacts from a widespread asian slowdown.
-- Reduced ability to build out infrastructure --
We have been expecting demand for fiber optic transport networks, cellular infrastructure, and even central office switches for basic telephony to be robust in Asia. In developing countries these are parallel networks deployed by new operators seeking to compete with existing monopolies. We expect deployments to still happen, although the pace is likely to moderate.
-- Demand among commercial customers is likely to soften --
The potential impacts here come across technologies and include: slower growth in cellular subscriber base; less demand for cellular airtime by existing subscribers; slower roll-outs of data networks; less need for high speed data transmission capacity, slower deployments of new FBXS. One way or another, eventually all this could trickle through to mean reduced equipment demand.
-- Weaker consumer purchasing power --
The biggest impact is on cellular and pagin markets. Asia is a key part of the growth story for cellular. Interestingly, a slowdown may affect both unit demand and the mix of product sold. Today in handsets, the Asian markets tend to have high exposure to the highest-end units. A shift to lower-end models would likely be a negative for the cellular handset manufacturers.
-- Threats of substitutes --
Higher price sensitivity and devalued currencies make local (i.e. Asian) substitutes more attractive. The impact is greater the nearer a product is to a commodity. We believe that the biggest risks are in network adaptor cards (3Com), modems (3Com), and pagers (Motorola, Nokia, Ericsson), and very low-end shared-media hubs (Bay, 3Com).
-- Second order effects --
1) Slower fiber deployment means less basic infrastructure to satisfy the needs of business customers, and this in turn could slow the deployment of data networking infrastructure within corporate customers as well as the expansion of internet capabilities within effected countries.
2) Slower growth for companies strong in the effected countries could mean that these companies become more aggressive in their other markets in an attempt to make up for missed opportunities.
We believe that Bay Networks, Cisco Systems, and Lucent Technologies are among the more "Asia-proof" of the stocks in out universe.
Bay and Cisco's greatest exposure is in Japan. A market that has been particularly troubling for Cisco over the last few quarters. But, we believe this business is likely to be least-impacted by the turmoils of Asia. Only about 5% of Cisco's sales come from the rest of Asia, and in the case of Bay, it is about the same. We have considered Asia an opportunity for Lucent particularly, as it is the only telecom equipment company for whom China is no the largest Asian market. Now this previous weakness perceived would appear to be a strength. Conversely, Lucent's strong position in Taiwan and Korea reflects the long-time relationships AT&T had in these countries. Nortel has slightly more risk than these three companies becaust it does have nearly 5% of sales in China, but its total Asian exposure is still relatively small.
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