TSC article. The Ax: Unshackled Lucent Threatens to Fell Cisco This Fall [ASND mentioned as most possible acquisition]
thestreet.com
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.
See Also
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8/6/98 5 PM
THE AX
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Milunovich
Takes the Ax
on H-P
7/23/98 2 PM
THE AX
ARCHIVE
Cisco
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