Daily Interview: BlueStone Capital's Susan Kalla

There's supply, and then there's demand. Susan Kalla has dug deeply into the demand side. And as communications-equipment sellers struggle with the sudden loss of visibility on their customers' spending plans and demands, we thought it would be good to chat with Kalla, a telecom analyst with New York investment bank BlueStone Capital.

Susan Kalla Networking Analyst for BlueStone Capital

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Kalla, a recovering GTE engineering geek, speaks proficient networkese and keeps in close contact with the 15 to 20 top network engineers who control the industry's purse strings. Kalla's roots are in market research. She was formerly a research analyst at Northern Business Solutions, now part of the Gartner Group.

Kalla initiated coverage on Ciena (CIEN Quote - Cramer on CIEN - Stock Picks) and Sycamore (SCMR Quote - Cramer on SCMR - Stock Picks) with rare sell ratings. This can be seen as a recommendation to short these stocks, to buy options with the expectation that the stock will fall. Among the things Kalla predicts is a continued consolidation of the phone and Internet service providers and, light at the end of the tunnel in the form of a rebound sometime in late 2002.

TSC: Why demand-side analysis?

Kalla: When I surveyed vendors on how much they thought they would sell for the year, I always got total projections somewhere between 125% and 150%. But when I surveyed the buyers -- who are never going to be biased on the high side -- they always gave more conservative numbers. And the reality is usually closer to what the buyers say. At least that's what 10 years of experience has shown me.

TSC: I'll cut to the chase: What are the buyers saying?

Kalla: Half of their budgets are already committed to nondiscretionary spending -- the long-term large-scale projects like conversion to optical from electronic devices. Those numbers are set usually three years in advance. It's the discretionary budget that's still up in the air. That's smaller projects. The service providers are pausing. They haven't released their budgets yet. To me, that's a bad sign. They could be deciding to cut some of the budget or lengthen contracts to conserve cash.

TSC: What patterns develop when carriers have less money to spend?

Kalla: A lot depends on the economy. When the economy is good and money is flowing freely, they'll buy the best thing. But when money tightens up, they will consolidate their purchases with one supplier so they can exercise greater power and get better discounts. At this point we are likely to see a consolidation with big vendors rather than trying to support 10 or 15 niche players. Cisco (CSCO Quote - Cramer on CSCO - Stock Picks), Nortel (NT Quote - Cramer on NT - Stock Picks) and Lucent (LU Quote - Cramer on LU - Stock Picks) are the big players, and the niche players would be Ciena, Sycamore, ONI (ONIS Quote - Cramer on ONIS - Stock Picks) and Juniper (JNPR Quote - Cramer on JNPR - Stock Picks).

TSC: As Cisco and other equipmentmakers have said repeatedly, if the economy starts to turn around in the first two quarters, the second half of the year will turn up rosy. Is that a little optimistic?

Kalla: You can't turn the spending on and off that quickly. Once you cut a project, you have to get board approval to get it going again. It takes more than two quarters for it to come back; it takes more like a year to come back. I don't think we'll see a dramatic upswing in the second half of the year if the first half is soft. Spending decision are on a six-month to two-year cycle. Once projects are gone, in my view, they're gone for a long time.

TSC: What ails the carriers?

Kalla: Kamikaze pricing by the dozen or so new companies caused a disruption among the existing carriers. The Worldcoms (WCOM Quote - Cramer on WCOM - Stock Picks) and AT&Ts (T Quote - Cramer on T - Stock Picks) were forced to drop prices and upgrade their networks to stay competitive. There were so many new players that pricing became irrational.

Europe is about a year ahead of where we are now. There are about 20 pan-European networks going after the same markets, and with that competition, they were cutting prices about 60% a year. Very few players can sustain those price declines and as soon as that pattern starts you see the bond holders and stock holders run.

TSC: So what is the outlook?

Kalla: From what I can see, it gets worse from here in the U.S. market. Telecom is a cyclical business. After consolidation in the industry there will be fewer stronger players. Then the prices will stabilize and we'll start all over again.

TSC: How long are telecom's cycles?

Kalla: Cycles are usually seven years, and we are probably one year into the downturn. So that will probably last for another year or year-and-a-half. It will be probably late 2002 when we start to see the upturn. Telecom is always a boom and bust. And there's no end of the entrepreneurs that are willing to innovate new services.

TSC: [Cisco CEO] John Chambers likes to say that with the advent of the Internet, all these cycles are getting shorter. Is that just Chambers trying to sell more Internet gear, or is there a faster cycle?

Kalla: The cycles used to be 15 years. So, yes, there is a compression of the cycles. And the communications cycles are always higher than the economic cycles. But even if the economy goes negative, you never have negative telecom growth and I've looked back as far as the late '60s.

TSC: Well, at least you've given the bulls one thing to cling to.