Slowdown Leaves Tech Firms Needing Windex for Their Crystal Balls
If the stock market were an airport, a lot of tech companies would be fogged in right now.
In fact, tech stocks have stalled recently because of a shortage of visibility. But it's possible that companies never had it in the first place.
Whether visibility -- roughly, the ability of a company to forecast its performance -- was real or an illusion in the past, companies' recent confessions of clouded visibility, says one analyst, are having a substantial effect on stock valuations. And predictions of a pickup in performance after the current tech slowdown may not be trustworthy, frankly.
Evidence of the visibility crisis is easy to find in earnings announcements and preannouncements during the past month:Communications-chip company PMC-Sierra (PMCS) says it has lost its visibility beyond the first quarter. John Chambers, CEO of networker Cisco (CSCO), says his company has lost its visibility. Internet incubator CMGI (CMGI), which once thought it could see as far as July 31, backed away from professions of visibility two weeks ago. Hewlett-Packard (HWP) CEO Carly Fiorina thought she had visibility last December -- that is, until someone, as she says, turned the lights out. One of the roots of the current visibility crisis, say some analysts, is that for many companies, visibility isn't much different from a driver predicting what the highway will look like ahead by what he sees in the rearview mirror. That theoretically might work -- but only if the highway is as straight as a ruler. Many companies have forecast earnings based on such factors as what their sales backlog looks like and their experience translating that backlog into results, says Rob Martin, senior new-media analyst at Friedman Billings Ramsey. "The trouble with that methodology," Martin says, "is that historical results, given the current environment, are no longer an indicator of future success, given the rapid deceleration of the overall Internet economy." In addition, different companies have different methods, and different records of success, when it comes to forecasting financial performance. Erik Suppiger, who follows networking companies for J.P. Morgan H&Q, says one element of visibility is repeat business, while another is new accounts. For Foundry Networks (FDRY), for example, repeat business is essential for visibility, he says, because the company has gotten 60% of its revenue each quarter from repeat customers.
Plus Ca ChangeSays Paul Sagawa, senior research analyst at Sanford C. Bernstein, "What passed for visibility was an assumption that things would stay the same." There's another reason that companies' vision has been clouded, Sagawa says: It's dependent on a process that's similar to the children's game of telephone, in which players pass a message down a line by whispering it into the next person's ear, usually resulting in a garbled mess by the end of the line. Top management at an equipment supplier, says Sagawa, gets a picture of the market from its sales department, which may be motivated to gild the lily. The sales department gets its cues from the engineering staff at customer companies -- people who may overstate their needs in order to get the best terms and access to equipment. Those engineers are limited by the budgets they get from their own companies' financial operations -- people, Sagawa says, who often rein in engineers' budgets, only to give in to their requests later on. In turn, financial managers at client companies ultimately get their budgets from the financial markets, he says. "It takes a long time for that to filter through in any meaningful way to top management," Sagawa says. "A lot of noise gets in the system." And that's why, he says, companies over the past few months have insisted that they see all kinds of demand for their products and services. "Then, all of a sudden, 'Omigod, we don't!' " Sagawa says. Though companies such as Yahoo! (YHOO) have predicted an online advertising recovery later in the year and Nokia (NOK) is predicting business will pick up in the cell-phone and wireless infrastructure businesses after a weak first quarter, analysts suggest that forecasts like these don't constitute actual visibility.
The Age of BeliefWithout referring to these companies specifically, David Brady, senior portfolio manager with the (SRYIX)Stein Roe Young Investor fund, says a lot of people -- himself included -- are making predictions about second-half 2001 recoveries in tech, based on the assumption that the Fed will continue to lower interest rates and that tax cuts will kick in by this summer, boosting economic growth. Yet, he says, "I wouldn't call that visibility, so much as guidance and a belief that what the Fed is doing is going to work." Any predictions of a second-half recovery in the Internet advertising market is "a company independently forecasting the health of the economy and the overall ad climate," says Martin of Friedman Billings. "It's an opinion. ... Not to say it's invalid, it's just an opinion," he says. Yet for all their misgivings about the validity of visibility, investors say there's a clear correlation between visibility and stock value. "The companies that understand and control their business best, see the future the best -- that is a differentiating feature between companies," Brady says. "Over the long term, it separates the breakaway companies from the rest of the pack." With lower visibility you get lower-value stocks, says Sagawa. "You can no longer have the same confidence in the earnings power of the high-growth companies that you're chasing," he says. "And because of that, you really shouldn't pay the same premium for them. ... Your view of an appropriate multiple has to contract." So if Cisco was trading at 100 times forward earnings a year ago, and now it's trading at 40 times, don't necessarily conclude it's a bargain, says Sagawa, whose firm hasn't done underwriting for Cisco. It may just be a function of the visibility thing.
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