Optical Spending Slowdown Pounds Networking Stocks

The optical networking equipment-sales picture came into crisper focus Monday, and Wall Street surely isn't liking what it sees.

It turns out that the cash crunch among telephone and Internet service providers that was expected to depress equipment sales next year has already begun to take effect, throwing more cold water on an already reeling networking sector. Upstart networking stocks dropped 10% and more Monday as investors worried that the onetime highfliers' sales and earnings would suffer.

The Tell'Oro

Dropping Amex Networking Index, today (top) and one year

A sobering industry report may have touched off the selloff. According to market researcher Dell'Oro Group, third-quarter sales of optical equipment sank 7% from second-quarter levels. The report, which was released Friday, shows total optical sales slumped $387 million in the third quarter, to $5.53 billion. The slowdown comes in the midst of what was supposed to be the biggest equipment-spending year in history.

Now that the spending slowdown has infected the market, even stalwart Wall Street bulls are conceding that no one will be immune. Monday morning, Morgan Stanley Dean Witter analyst Christopher Stix cut his ratings on optical equipment makers Juniper JNPR and Redback RBAK, to outperform from strong buy. Juniper plunged $25.38, or 16%, to $129, and Redback dropped $9.75, or 12%, to $71.

Some optimistic analysts and investors had maintained that companies riding breakneck optical growth, such as Nortel NT, or those cashing in on the unparalleled Internet data explosion, such as Juniper, would be well-positioned even in a slowdown. Now it appears the cash crunch is being rather indiscriminate; even juggernauts like Cisco CSCO are now seen as lying directly in the path of the avalanche.

The Law of Big Numbers

The Dell'Oro report showed the big losers to be Lucent LU, with sales down 14%, Alcatel ALA, down 19%, and Nortel, down 6%. The report also showed that Ciena CIEN and Cisco both showed quarterly sales gains, to the tune of 17% and 25%, respectively. Both companies, however, are relatively new to the market and have a smaller base to work from.

Morgan Stanley's Stix lowered his price target on Cisco to $75 from $90. He also lowered his target on Extreme Networks EXTR, to $105 from $135. Cisco was off $2.44, or 4.6%, to $50.31, while Extreme was off $8.94, or 12%, to $64.38.

Lehman Brothers equipment analyst Tim Luke also weighed in Monday, echoing comments made Friday by Banc of America's Chris Crespi to the effect that Nortel will be hard pressed to rally after last quarter's optical-sales disappointment. In its third quarter, Nortel was blindsided when customers WorldCom WCOM and Qwest Q began hoarding optical equipment, boosting shipments but punishing sales figures because of the added lead time between when gear is shipped and when it is considered sold. The warehousing effect pounded the stock. As WorldCom and Qwest work off their stockpile, it remains unclear whether Nortel can recapture its stride, particularly as the spending cooldown takes hold.

Roll the Video

To counterbalance the negative news on spending, Don Smith, Nortel's optical Internet chief, points to a $400 million, three-year sales contract with the Teleglobe arm of BCE BCE, announced Monday. The contract calls for sale of Nortel's Optera fiber-optic transport gear, which will help Teleglobe fire up new stretches of its network in North America, Asia and Europe.

The Teleglobe deal, says Smith, "reaffirms that carriers continue to spend money on new technologies that will better enable them to better serve their customers with faster and more reliable services."

Nortel has an analyst meeting in Boston Tuesday to help clarify its sales outlook. Though analysts don't expect any significant change, some people expect that Nortel will try to dazzle the crowd with glowing customer testimonials on video. In this environment, though, investors don't seem inclined to be impressed.