Clash of the Titans: Cisco, Lucent and Nortel Go to War Over
Switching Technology
By Bill Alpert (Barrons)
The geeks call it a war between
packets and circuits. We savvy folks at
Barron's recognize it as a war between
California and New Jersey. We're talking
about Cisco Systems versus Lucent
Technologies. Oh, we know Northern
Telecom's in the fight, too, but if we
said Canada was under attack, you'd
think we were joking.
A deadly serious war is escalating
between Cisco and Lucent, each
boasting a huge and widely owned stock
that has tripled in the past six months.
The rhetoric is rough. Lucent chief
executive Richard A. McGinn reportedly
has "Wanted" posters with the mugs of
his rival chiefs at Cisco and Nortel.
Cisco folks dismiss their Jersey rivals
as "Old World" or, worse, "proprietary" --
as if Lucent were decaying like parts of
Asbury Park's boardwalk. In a battle of
the bands, you'd think of Sugar Ray
versus Springsteen.
Leading Cisco's troops into Lucent's
theater of operations is Don Listwin, a
40-year-old executive vice president and
No. 2 to CEO John T. Chambers. Listwin
is the San Jose firm's key strategist. He
drove the firm's successful assault on
IBM's proprietary scheme for networking
mainframes to other computers. The
IBM networks were hierarchies bossed
by a mainframe. Cisco and others
toppled that hierarchy with democratic
peer-to-peer networks.
Listwin describes his work as
"deconstructing" old-fashioned
networks. "The decade of the 'Nineties
has been about the deconstruction of
the proprietary technologies of the
computer companies," he says. "The
next 10 years is going to be the
deconstruction of the proprietary voice
systems."
Cisco's out to
deconstruct in the
physical and
intellectual sense.
Listwin needs to
debunk the concept
-- or mental
construct -- that you
can't get fired for buying Lucent, just as
he did with IBM. Apart from the implied
public benefit, Cisco would benefit
financially if it can add the public phone
market to its traditional data market.
Although the Internet's booming,
corporate purchases of network gear
recently slowed a bit for the likes of
Cisco and 3Com. Still, Listwin says the
$40- billion-a-year market for corporate
data networking should continue to
grow 20%40% a year.
With Cisco's annual growth surpassing
30%, and its July 1998 fiscal year sales
at $8.5 billion, Listwin's eager for
inroads on the $350 billion-a-year
market for telco gear. And in the last
year, he says that piece of Cisco's
business has been growing at better
than 50%.
Listwin sees a financial trap waiting for
Lucent and other suppliers of traditional
phone switches. He calls it the "TDM
trough." Time Division Multiplexing, or
TDM, is the technology of phone
networks topped by switches like
Lucent's 5ESS. This regime reserves
part of the wire for each phone
conversation, in the way that Amtrak
holds back its track from local
commuter trains during time slots
scheduled for its express trains --
regardless of how empty those express
trains may be. The Internet style
network championed by Cisco allows
data packets on any empty wire, like
cars darting onto a highway. This
packet-switched approach should be
cheaper to build and operate than TDM
circuits. Emerging phone firms like
Qwest Communications say they'll buy
no new voice switches. So the rise of
Cisco-powered networks could undercut
sales of TDM gear like Lucent's 5ESS,
warns Listwin, faster than Lucent can
grow its own sales of Cisco-style gear.
That would cut a TDM trough in Lucent's
financials.
But even if time-division technology
becomes passe, timing will still be
everything in investing. And the Old
World of TDM hasn't the decency to die
off as quickly as Listwin might hope. On
the technology level, the networks
offered by the likes of Cisco can't yet
match the bomb-proof reliability of
old-fashioned phone networks. As most
commuters know, a well-run train is
more reliable than a rush-hour highway.
Data packets on the Internet frequently
get dropped or delayed -- if only for
milliseconds. A Web surfer won't notice
fractional second halts in her screen
displays, but a salesperson won't
tolerate fractional second dropouts
when she's talking to a prospect.
Cisco and the Internet community are
beefing up their protocols to improve
transmission quality. Voice packets and
business data would ride First Class,
while flat-rate admirers of Pamela
Anderson Lee's curves would travel
Coach. Listwin says these
service-quality protocols will be
available across Cisco's product line
this summer, although developing
industry standards will take longer.
Technology is one matter. Economics
are another, points out Dave McDonald,
who follows telecom stocks for Essex
Investment Management in Boston.
Even after the fact of legal deregulation,
notes the money manager, market
forces don't necessarily blow at
hurricane speeds. The long-distance
oligarchs at AT&T, MCI WorldCom and
Sprint want to protect their terrifically
profitable businesses.
"If you can charge 10 cents a minute
and your costs are three cents a
minute," asks McDonald, "why drive
down prices?" And if phone service
oligarchs are happy to milk their quaint
TDM networks, then their oligarchy of
suppliers like Lucent and Northern
Telecom needn't beat up on each other
either, reasons McDonald.
Another aspect in
timing a potential
TDM trough is the
human factor. The
cycle of selling to
phone companies is
long and arduous,
says McDonald, and
once the telcos get comfortable with a
supplier, they'll buy for years. Lucent
has a terrific sales force with a foot
already in the door at hundreds of phone
companies.
Crusaders against TDM took heart last
year, when Paris-based Alcatel
announced a sales shortfall. Then
Lucent reported weak sales growth of
only 6% for its December quarter, with
U.S. network sales actually declining
from the year-earlier level. Careful
scrutiny of Lucent's accounting,
moreover, showed negative cash flow
from operations, earnings padded by
noncash credits and liberal exploitation
of R&D writeoffs after acquisitions -- a
controversial technique for helping
investors forget the cost of acquired
earnings.
Has Lucent fallen in the TDM trough? No
way, says Carly Fiorina, president of
Lucent's global service provider
business. Last week, Lucent reassured
investors that per-share earnings for its
second fiscal quarter, which ended
March 30, would meet or exceed
expectations of 15 cents a share.
Revenues would likely exceed $8 billion,
a 30% rise over the prior year. Fiorina
says investors should be pleased by
Lucent's receivables, too, when the firm
reports April 22.
The service provider business that
Fiorina runs accounts for about
two-thirds of Lucent's $30 billion in
annual sales, and it includes the 5ESS
switches that represent the throne of
the TDM empire. About 295 customers
use the 5ESS worldwide, says Fiorina,
making for record sales and profits in
that Lucent business.
The price of switching is dropping like
other electronic gadgetry,
acknowledges Fiorina, with current
world prices averaging $90-$100 a
phone circuit (outside of the protected
turf of France's Alcatel and Germany's
Siemens -- see "Siemens.com" for more
on the latter -- where prices are triple).
But 5ESS sales are growing at a 44%
rate, as measured in circuits, says
Fiorina. Lucent is gaining share from its
global switch rivals, with Lucent's
international sales growing nearly 70%.
The market for gear like the 5ESS
should grow at double digits to $33
billion by 2001, she expects.
Not that Lucent expects those stats to
extend out 10 years, but Fiorina sees no
TDM trough for three to five years.
"Packet-based technologies are
disruptive," she freely concedes, "and
Lucent Technologies is investing
billions of dollars to provide
packet-based technologies to our
customers."
Witness Lucent's planned acquisition of
Ascend Communications, the Cisco rival
that will bring to Lucent a technology for
carrying voice and data called
Asynchronous Transfer Mode, or ATM.
Essex money manager Dave McDonald
thinks phone firms will use ATM as a
packet- toting technique for the next
few years, even if Cisco's Internet
technology improves in quality.
Acquisitions will prove crucial to both
Lucent and Cisco, which itself just
purchased two firms whose products
bridge Old World voice networks to New
World packet networks.
That's why the California and Jersey
firms have made their war so public.
Because they need to acquire, their
stock price is as strategic an asset as
their technology and customer list. Both
firms want the high esteem, and
estimates, of Wall Street. But not for
their rivals.
What's in it for you? No one listens only
to New Jersey bands, nor only to
California's. Dave McDonald owns both
stocks, saying: "The market is going to
be big enough for both of them."
COVER ILLUSTRATION: Scott Pollack
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