The Coming Year: Communications
Networkers Must Live Up to the Hype
By Kevin Petrie
Staff Reporter
1/7/99 11:09 AM ET
Communications-equipment makers such as Cisco
(CSCO:Nasdaq), Lucent (LU:NYSE) and Ascend
(ASND:Nasdaq) ended 1998 full of holiday cheer
thanks to Wall Street's continued love affair with their
stocks. This year, they'll have to prove they are worth
their high premiums.
The top 10 builders of communication networks saw their shares swell by an
average of 58% this year, even though their revenue ticked up only 14% and
operating profits gained an average 4% in the four most recent quarters
reported by each company.
Cisco's stock grew 150% even though the company increased revenue
34%; rival Lucent also added 175% to its market value as it posted 14%
gains in revenue. Cisco trades at 101 times its profits for the past four
quarters, and Lucent trades at 156 times trailing earnings. Ascend and
3Com (COMS:Nasdaq) have also thrived lately, while laggard Cabletron
(CS:NYSE) appears to be in a tailspin as losses mount.
"The haves are gonna have a lot more, and the have-nots are gonna have a
lot less," says Craig Johnson, principal with the Pita Group consulting firm
in Portland, Ore. Johnson estimates that the 10 major players in
communications equipment will grow revenue roughly 20% to 25% in 1999.
Not so with the smaller guys.
In 1999, all eyes will once again turn to Cisco and Lucent, the two dominant
players in this sector. Cisco, for its part, has firmed its foundation in the
business of tying corporations to the Internet. There is little sign that
corporations have slowed their capital spending, which bodes well for Santa
Clara, Calif.-based Cisco. This year's formidable task is to work on making
the Internet reliable enough to carry telephone calls without a loss in quality.
On the other hand, Lucent, a longtime supplier of equipment to phone
companies, needs to improve its Internet applications. Optimism about the
move of telephone systems onto the Internet partly explains why investors
are pushing stocks so high.
But even bulls advise caution.
"Before we join hands to usher in this 'golden age of networking' when all
media [including telephone, data, television, radio, photography, fax, etc.]
converge into a single integrated network, there are some technical issues
to be resolved," wrote J.P. Morgan analyst Bill Rabin in a recent report
titled "The Secret Sauce of Convergence."
The good news for equipment builders is that network carriers are investing
serious money today in tomorrow's network. Long-distance carrier Sprint
(FON:NYSE) hired Cisco to help construct its ION network, designed to
integrate voice and data messages, and expects to activate initial ION
services in mid-1999. Next year, the Baby Bells will increase their capital
spending on data networks 25% to 30%, according to estimates from
analyst Tim Savageaux with San Francisco-based investment bank Volpe
Brown Whelan. Revenue from data services is growing at about a 35%
clip, Savageaux says.
Conversion of voice and data could be a win-win situation for both
companies. Cisco and its peers understand more fully just how computer
networks are stitched together, and they pounce quickly on changes in
customer demand, according to Rabin. Lucent and Canadian telecom-gear
maker Nortel (NT:NYSE), for their part, have expertise in the arcane
signaling controls for telephone calls -- which must be layered onto the
"converged" network of tomorrow.
Investors continue to pour money into Cisco stock. "It is expensive by any
stretch of the imagination," Rabin says. But he will not downgrade Cisco, by
all checks a strong company, just because it's pricey. "I have trouble being
negative if the market is overly optimistic."
Carriers are the focus because of a fundamental change in the networking
world. Corporations are demanding rebates from networkers competing for
their business. Market tracker Dell'Oro Group estimates that prices for
local networks will fall an average 9% in 1999, after falling 7% last year.
Competition is still tightening, mostly to the detriment of smaller players.
Cabletron's sales and profits have continued to grow weaker; after bolting to
the sky, Ciena (CIEN:Nasdaq) lost critical business contracts and was left
at the altar by Tellabs (TLAB:Nasdaq). Next year, nimble start-ups such as
Juniper Network and Terayon intend to challenge Cisco with their
routers. But for the time being, Cisco, Ascend, 3Com, Lucent and Nortel
have planted firm feet in most of the networking yard.
J.P. Morgan's Rabin expects more consolidation. Driving this trend is the
need for carriers to procure products from just a few vendors with worldwide
reach. For example, in order to gird for the battle of convergence,
phone-gear supplier Nortel acquired Bay Networks in late summer.
"The combined market will be dominated by four or five giant equipment
vendors, each offering a full set of products and services, while mid-cap and
small-cap companies will probably either be acquired or crushed by the
competition," he says.
|
