Nortel Betting Big on Second-Half Economic Bounceback

Sure, Nortel (NT) encountered a slowdown in equipment spending last quarter. But it hastens to add that, Fed willing, the second half of the year will see a telecom spending rally.

The networking equipment giant Thursday met Wall Street's earnings expectations and slightly exceeded the consensus revenue growth goal. But the Toronto company's comments in a conference call confirmed investor concerns about the emerging slowdown in near-term growth for the networking sector, even if those remarks were leavened with plenty of bullish caveats.

In what may be a preview of guidance to come from other networking outfits, including Cisco (CSCO), Nortel put its revenue forecast for the first quarter at $8.1 billion; analysts had expected $8.2 billion. The company now calls for 30% growth for 2001, putting it at the low end of its previous 30%-to-35% range.

The company said on a conference call with analysts Thursday evening that, due to an increasingly uncertain economic outlook and tightening capital spending among its customers, Nortel's view of its growth is less clear now than it has been. But in almost the same breath, the company reassured investors, saying it is assuming that the Federal Reserve will continue to reduce interests rates, freeing capital to flow once again in the second half of the year. After a 6% gain in regular Thursday trading, Nortel jumped to $2 to $38.88 in after-hours action on Island, as investors bought the Nortel line.

Blaming the Markets

Providing little by way of detail on the quarter, Nortel President and CEO John Roth said demand didn't go away, but capital markets tightened up. He said customers were making buying decisions based on smaller budgets -- but if access to cash improves, the floodgates will open.

"If capital markets start to improve, we could see a tremendous resurgence in the second half," Roth said. "It all depends on how the markets behave."

That is pinning a lot of hopes on the second half of the year, but over the past year Nortel has seen more than 10-fold growth in optical networking sales and a dramatic uptake of wireless infrastructure sales. Fanned by those winds, Nortel believes that its growth will continue, albeit at a more conservative rate.

The maker of networking gear said fourth-quarter earnings were 26 cents a share, in line with analysts' estimates, according to First Call/Thompson Financial. Fourth-quarter revenue was $8.8 billion, up 34% over the $7 billion levels a year ago.

For the year, Nortel said net profits from operations were $2.31, or 74 cents per share, an increase of 42% over the 52 cents per-share level for 1999. Revenue for the year was up $9 billion, or 42%, to $30.3 billion, over the $21.29 billion in sales in 1999.

Eggs in One Basket?

Not everyone's so sure about the second-half upturn Nortel's betting on. "No one knows how the economy is going to unfold," says ING Barings analyst Tom Lauria. "But if the economy doesn't ramp up in the second half, it could turn out to be a critical issue for Nortel's results, Lucent's (LU) results and even Cisco's results." Lauria, who reduced his rating on Nortel to buy from strong buy last month, predicts Nortel will reach 28% sales growth this year. ING Baring has done no underwriting for Nortel.

Some observers thought a pullback in guidance to 27% growth would be in order, given the deterioration of visibility -- the ability for a seller to forecast the buying trends of its customers.

There is a significant downside ahead for Nortel shares if the company's actual growth fails to justify its price-to-earnings ratio, which is about 35 based on 2001 estimates. In other words, investors are expecting a 35% growth rate, so anything below that will likely hurt the stock.

"In reality, visibility is more limited than it was one or two months ago for all telecom equipment companies," Lauria said. "So no one can know how the next few months will turn out."

In these times of uncertainty, though, Nortel seems to lean toward the optimistic side of the house.

>To order reprints of this article, click here: Reprints