Qwest Trims Spending, and Cisco and Ciena May Get Pinched

Qwest(Q) is sharpening its knife, planning to cut capital spending more, in a move that promises to trim the outlook for networking gear suppliers like Ciena (CIEN), Nortel (NT) and Cisco(CSCO).

Qwest is preparing to cut its network expansion budget another $400 million, or 4%, bringing its spending plan down to $8.8 billion this year, as it cancels some network projects and finds better discounts from equipment suppliers, says Lehman Brothers' analyst Blake Bath.

Notably, the Denver-based Baby Bell was one of only two major telcos that originally planned to increase spending in 2001. Now, instead of a 5% increase over the $9 billion it spent last year, Qwest likely will spend 8% less than its original 2001 $9.6 billion forecast.

A Qwest spokesman declined to comment Thursday.

The anticipated cut from Qwest, plus the latest announced spending reductions by Genuity (GENU), add more momentum to the overall telco spending decline this year. The latest trimmings come only a week after big gear buyers Sprint (FON) and 360networks (TSIX) both sliced $1.75 billion from their 2001 equipment-purchasing budgets.

Like Jed Clampett Sitting on the Porch

Qwest has been whittling away at its spending budget since it entered the year. Last month it said it was cutting $300 million from its planned 2001 equipment outlays.

"Qwest is seeing lower pricing on equipment, and they said they've decided not to pursue some systems projects," says Bath, who rates the company a strong buy. (Lehman handled some of Qwest's bond sales earlier this year.) According to Bath, those systems projects include a $100 million internal data networking effort.

Qwest has made no secret of its intention to save money through spending cuts or by playing sales-hungry suppliers off each other. Qwest also boasts that it has found nearly new gear in unopened boxes on the used market, either through brokers or directly from small telco liquidations.

Bath says these cash conservation efforts will help make Qwest cash-flow positive by mid-2002. Bath was one of the first analysts on Wall Street to charge the telcos with overspending. He warned last fall that the service provider industry was in danger of spending $1 for every $2 it brought in, something that's unsustainable and well above the normal $1-to-$4 ratio.

In addition to handling local phone service in 14 western states, Qwest operates one of the nation's largest optical-fiber networks. With less than 5% of its network equipped and running traffic, it was assumed that Qwest would continue to buy things like switches and routers at a mad clip to handle increases in communications traffic.

Pulling Back on the Reins

Bath says the original assumptions about this wild spending have been reigned in. He says next year Qwest likely will spend $8 billion, or 10% less than this year, and even less in 2003. This, of course, provides more evidence that the biggest spending period is behind us and that equipment makers face much more slack in the supply rope until demand starts pulling again.

If Qwest has been hacking at its capital budget in small increments, Genuity has been wielding a machete on its spending in order to bring costs more in line with funding.

The data service provider that was spun from GTE and Bell Atlantic last year said this week that it was cutting about $3.5 billion, or 44%, of its four-year network spending plan. This translates to a cut this year of $800 million, or 36%, bringing the 2001 equipment budget to $1.4 billion, according to estimates by research shop Epoch Partners.

Among the suppliers most directly affected by the recent cuts are Ciena and Nortel, which sell optical transport equipment to Genuity and Qwest. And router makers Cisco and Juniper (JNPR) also are on the hook as these companies pare back on spending or ask for bigger discounts.

While Cisco has already demonstrated great difficulties selling gear to phone companies, some investors are even leery of the stronger performers like Ciena as the service provider sector continues to struggle.

Receding

"About 60% of Ciena's business is long-haul optical transport, and that business is receding," says a Wall Street-based hedge fund manager who has no position in Ciena.

A recent Dell'Oro Group report supports that observation. Optical transport market sales, where Ciena is the sixth-largest player, fell by 22% to $4.8 billion in the first quarter compared with the fourth quarter.

This is troubling for Ciena, which "hasn't given any downward guidance yet," says the hedge fund manager, who asked not to be named.

This spending cut on optical gear is even more troubling for Nortel. Notably, Nortel's share of that market fell to 29% from slightly more than 50% in the prior quarter as rivals, including Lucent(LU), Marconi(MONI) and Ciena, swiped sales from the once-dominant optical shop.

So while the more established telcos are punishing suppliers for better prices in this buyer's market and the smaller, more poorly funded phone and Internet service providers are grappling to survive, networking stocks aren't likely to stabilize anytime soon.

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