More Ill Winds for Networkers as Even Hearty SBC Cuts Back

SBC (SBC Quote - Cramer on SBC - Stock Picks) Monday trimmed earnings estimates and cut its capital-spending budget, setting off more alarm bells in the telecom-equipment sector.

Pointing to everything from California's slumping economy to heavy competition, SBC trimmed earnings estimates for the year, declined to forecast revenue growth for 2001 and said it wasn't "anticipating an uptick in the economy for the remainder of this year." SBC stock dropped fractionally, but the real pain was felt in the networking sector, home to companies that make the gear that big telecommunications firms use to build and operate phone and data networks.

Most worrisome for tech investors was SBC's plan to slash 2001 capital spending by $500 million, or around 4%, to $12 billion. Though relatively minor in dollar terms, the effect of that move will be felt by makers of gear for telecommunications networks, such as Nortel (NT Quote - Cramer on NT - Stock Picks), Lucent (LU Quote - Cramer on LU - Stock Picks) and Cisco (CSCO Quote - Cramer on CSCO - Stock Picks), all of which dropped 5% or more Monday as the networking sector led a sharp drop in the Nasdaq. That's because when a company as strong as SBC is cutting back, say analysts, investors know to brace themselves for copycat moves from telecom service rivals.

Chinese Water Torpor

SBC's move looks particularly bad for networkers because, even as dot-coms and upstart telcos began to sink last year, bulls believed spending by the big local and long-distance phone companies would fill the breach. Now, as the likes of SBC begin to chip away at their still-considerable budgets, an already dim equipment-buying outlook is appearing darker and darker.

"This is Chinese water torture," says Trade.com analyst Susan Kalla, who was among the first to flag the end of the network spending boom. "Every quarter or midquarter, the carriers announce a little more in cuts."

SBC, the nation's second-largest local phone service provider, has already trimmed its network expansion budget by 2% from a year ago. Now investors must keep an eye on the industry's other top spenders, Verizon (VZ Quote - Cramer on VZ - Stock Picks), AT&T (T Quote - Cramer on T - Stock Picks) and Qwest (Q Quote - Cramer on Q - Stock Picks), all of which are scheduled to report quarterly earnings Tuesday. These companies have yet to cut their capital spending outlook from their original projections at the beginning of the year.

Predictive

What worries Kalla the most about SBC's capital spending pullback is that there's no sign that an end is in sight. "By the end of the year it could be 10%, and that would be significant," says Kalla, who has no rating on SBC but recently cut stock price estimates on equipment makers Ciena (CIEN Quote - Cramer on CIEN - Stock Picks) and Juniper (JNPR Quote - Cramer on JNPR - Stock Picks), both of which fell sharply Monday.

"I think this is predictive of a trend for the Baby Bells," adds Kalla. "I mean, they're all pursuing pretty much the same business. They only differentiate themselves by region."

There is plenty of reason to believe the big telcos will cut their spending to match SBC. Last week, for instance, Sprint (FON Quote - Cramer on FON - Stock Picks) cited slower-than-expected growth in saying it would review its spending plans. The nation's No. 3 long distance provider entered the year seeing pent-up demand for new gear and a 50% rise in its equipment budget. A Sprint spokeswoman says the company hasn't made any budget decisions, but observers say it is likely to trim its $6.2 billion plan.

California's energy problems and the collapse of tech companies contributed mightily to SBC's first-quarter revenue woes, executives said on a conference call with analysts Monday. While outlining the overall weakness in the business, SBC execs said new orders for consumer lines and services dropped 6.9% and total call times dropped 3%. On the business side, billable minutes fell 11%.

First-quarter earnings dropped 9% to 51 cents a share, within the lowered range that analysts had expected. SBC cut its 2001 guidance, putting earnings at between $2.35 and $2.40 a share, below analysts' expectations of $2.46 a share. Given the protracted slowdown, company executives declined to give revenue growth projections for the year.