from thestreet:
The Ax: Unshackled Lucent
Threatens to Fell Cisco This
Fall
By Kevin Petrie
Staff Reporter
8/19/98 3:22 PM ET
Look out Cisco (CSCO:Nasdaq) investors -- this
no-brainer of an investment may turn tricky again.
So says J.P. Morgan's Bill Rabin,
TheStreet.com's incumbent ax on the key
technology play. So far this year -- while fledgling
networking superstars such as Ciena
(CIEN:Nasdaq) have blown up -- Cisco's success
in the business has made things rather easy for
him and the rest of Cisco's analysts.
Still, Rabin's recent advice on Cisco has not hurt
his cause. He hit a bull's-eye two weeks ago,
accurately predicting what Cisco would report for
its fiscal fourth quarter. The Cisco ax presciently
said that Cisco would earn 48 cents per share on
revenues of $2.4 billion. After the conference call,
he raised his firm's 12-month price target to 115
from 88. The stock passed 100 on Tuesday and
was trading at 103 3/8 today. Rabin's firm, which
has had a buy rating on the stock for the past three
years, has no underwriting history with Cisco.
With Cisco's tight guidance, however, Rabin says
the only real concern his clients have had is when
they should take some profits off the table on the
expensive blue-chipper. Cisco trades at 81 times
trailing earnings and 46 times the earnings of
$2.18 per share he expects for the company's
just-started fiscal 1999. Rabin says he has told
them to stick with Cisco despite the steep
valuation unless they decide there are fundamental
problems. He doesn't see any. And so far, this
simple analysis has paid off for his clients: Cisco is
up 80% year to date.
This fall, however, the picture changes.
"The magic date in the industry right now is Oct. 1,"
says Rabin. That's when Lucent (LU:NYSE) will be
free to acquire large companies using more
favorable accounting, according to the terms of its
1996 spinoff from AT&T (T:NYSE).
After two full years as a standalone
concern, Lucent then will be able to
use pooling accounting methods
instead of purchase accounting --
meaning it doesn't have to write off
goodwill and dilute future earnings.
So, in other words, Lucent can
extend its burgeoning
telecommunications venture into
Cisco's Internet business with a
large acquisition without financially handicapping
itself in the short term. If Lucent buys Cisco's
competitor Ascend (ASND:Nasdaq) -- something
all three Cisco analysts featured in this story think
is possible -- Cisco's horizon will grow cloudy this
winter as the two behemoths raid one another's
backyards. Even if the merger doesn't occur,
Lucent will become a fierce competitor by the
spring.
Either way, "it's going to be an exciting time for
analysts trying to get that fundamental shift right,"
Rabin says. He says Cisco has the early lead
because it already landed a contract to build a
risky data and telephone network for Sprint
(FON:NYSE).
Note to J.P. Morgan clients: Rabin now writes
reports and speaks to clients jointly with Greg
Geiling, J.P. Morgan's Lucent analyst. And Geiling
thinks Lucent has the drop on Cisco.
Other Cisco Ax Contenders
Peter Swartz at Salomon Smith Barney also is
looking forward to the fall. Swartz, a relative
newcomer who hopped from corporate finance to
equity research only three years ago, is quickly
becoming an analyst to be reckoned with in the
networking space. Already, The Wall Street
Journal picked out Swartz for his stock-picking
skill back in June.
Right now, admits Swartz, Cisco is a "boring"
stock. But that's because he doesn't have to worry
about its product cycles or inventory levels with
distributors because it has built such a solid
position.
Even at its valuation, he argues that Cisco stands
as a rare safe play in all the technology tumult. "For
the next six months, I think investors are looking at
which stocks are not going to lose me money,"
Swartz says.
Beyond that, however, the Solly networking analyst
has some concerns. First, risk-averse Baby Bells
may remain hesitant to purchase new Internet
products, and, second, "supercarriers" like AT&T
might punish Cisco if it sells to certain competitors.
In addition, Swartz agrees with Rabin that the
Lucent thing should make things much more
interesting in this space. For years, an army of
Lucent engineers has reliably furnished
corporations and carriers with all the telephone
products they need, tip to tip. Cisco misses certain
crucial parts of the puzzle, such as optical products
that Lucent offers.
In its favor, Cisco managers have been able to
finesse rapid product transitions, find the right fit
with partners and acquisitions and ship great
technology, according to Swartz. Cisco also
dominates higher-growth markets. Overall, Swartz
says it's too early to pick a winner. He's rated
Cisco a buy for over two years and predicts the
stock will rise to 120 in a year. His firm is not a
banker for Cisco.
George Kelly, a perennial Institutional Investor
first-team all-star with Morgan Stanley Dean
Witter, finds it interesting that Cisco trades at its
highest price-to-earnings ratio in its history and its
growth rate is the lowest.
Still, Kelly tells investors to buy at this price for
three powerful reasons: The AT&T-TCI
(TCOMA:Nasdaq) merger represents huge
potential business, Cisco won the lucrative Sprint
contract and portfolio managers are willing to pay
a price for companies that hit profit goals every
time. He has rated Cisco a buy since he and
Morgan brought it public in 1990, at less than one
dollar per share on a split-adjusted basis.
For the record, Kelly and his firm have brought
much of the data-networking sector public. But
that's a plus, says one West Coast money
manager. "That's why he's good, he knows
everybody at the highest levels."
Like Swartz, Kelly declines to call an early winner
in the Cisco-Lucent bout. They will "compete for
the jump balls" -- parts of Internet telephony, for
example -- rather than grab one another by the
throat.
"Neither company wants to destroy the other's
margins through competitive pricing," says Kelly,
who has a price target of 105 for Cisco.
The eternally bullish Kelly recently raised his 1999
annual earnings estimate on Cisco to $2.20 per
share from $2.18 based on the start of two new
upgrade cycles in Layer 3 switching and
voice-data products. |
