SBC Warning Gnaws at Cisco's Plans

Cisco's (CSCO Quote) entry into telecom equipment sales may have once seemed like a cinch. But lately the gear maker has been feeling the pinch.

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The latest setback for the computer-networking giant came Tuesday, when SBC (SBC Quote) cut its profit and sales forecasts for next year. Foremost among problems at the nation's No. 2 local phone company was a slower-than-expected expansion of digital subscriber line, or DSL, high-speed Internet service.

Wall Street sold Cisco on the news and asked questions later, pushing the stock down $1.19 to $41.75 in a late-afternoon tech rout. Cisco has a $1 billion contract with SBC to provide data networking equipment, specifically for SBC's high-speed Internet access rollout. SBC plunged $6.75, or 13%, to $46.56.

The Ironing Board

SBC said DSL installations in the Midwest, the territory acquired in the Ameritech merger, aren't progressing as rapidly as expected. Specifically, regulatory wrangling over how SBC should share its phone gear with competitors and a shortage of installation crews have hampered the effort. Because of that, SBC says it will take a "measured" approach to DSL installation until these issues are ironed out.

On a conference call with analysts, SBC said the slowdown in DSL expansion wouldn't change its agreement with Cisco. A Cisco spokesman declined to comment during a phone interview, but emailed the following response: "We do not comment on deployment schedules for individual customers, but we are working closely with SBC and continue to meet necessary milestones for building out the next generation DSL network."

Two analysts said they felt a touch of deja vu and pointed out that AT&T (T Quote) had made similar comments about how its troubled efforts in broadband wouldn't hurt its suppliers. But within months, suppliers like Antec (ANTC Quote) and Harmonic (HLIT Quote) were sent reeling by contract cutbacks.

Leveling Off

SBC also said it wouldn't increase capital spending next year. The company expects it will spend approximately the same amount next year on network equipment and other expansion as it has this year. SBC puts that figure at $12 billion. Early in 2000, investors and analysts were betting industrywide spending would continue to rise in 2001, boosting the prospects of gear pushers like Cisco.

But lately the pressures of a spending slowdown, combined with Cisco's exposure to cash-strapped phone and Internet service providers, have trimmed nearly a quarter from Cisco's market capitalization in barely a week.

Slowdown fears were heightened last week, when Cisco disclosed a $275 million provision for potential losses from such things as deadbeat customers. Cisco clarified the provision Tuesday with a regulatory filing. The company said it increased doubtful account provisions to $14 million from $5 million a year ago. Cisco also doubled its provisions for inventory reserves, to $143 million from $70 million. Typically, provisions for inventory mean the company isn't selling as much product as it expected to. The remaining $118 million of the provision was used to cover potential losses on investments.

Expect investors to keep a close eye on the changes in these provisions in coming quarters as spending continues to drop and inventory piles up.