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The networking companies are desperately trying to regain their balance, but it won't be easy.
Nortel's
(NT)
warning Friday may have served to shake even the most optimistic investor, as the company said it doesn't see any pickup in sales until the middle of next year. And while Nortel takes on water,
Lucent's
(LU)
cracked hull seems to have opened wider. With its bonds trading Friday at 50 cents on the dollar and its stock falling another 7% to the low $6 range, the company is urgently in need of an overhaul, analysts say. Particularly daunting is its bloated cost structure, which will get renewed scrutiny as leaner Nortel moves to cut more jobs.
Having spent wildly for the past two years building new networks, phone companies are now consolidating, folding up shop or freezing their equipment budgets. This cycle of overspending and underspending has whipsawed the equipment suppliers, who must in turn drastically reduce their operations. That means continued cuts in products, staff and inventories, say some analysts. In other words, the networkers must restore balance to their balance sheets.
"This year will be a disaster," says buy-side analyst Bob Rezaee with
Montgomery Asset Management
. "Next year will be a difficult but stabilizing year, and by 2003 the global economy should begin to improve and we'll probably see some modest recovery."
With
JDS Uniphase's
(JDSU)
Thursday
warning still reverberating through the market, Nortel on Friday delivered its own
preannouncement blow by forecasting a staggering $19.2 billion in losses for the second quarter, including a $12.3 billion writedown of premiums it paid for acquisitions. Excluding restructuring charges, the company expects to lose 48 cents a share on $4.5 billion in revenue. Notably, analysts had expected the company to lose 6 cents a share on revenue of $6.2 billion, according to
Thomson Financial/First Call
.
As the largest communications equipment maker in the world, Nortel's outlook speaks loudly about the prolonged downturn in gear sales due to cuts in spending by cash-crippled phone and Internet service providers. With all their fortunes tied to equipment spending, Nortel, Lucent,
Cisco
(CSCO) - Get Report
and the like won't see appreciable improvements until the service providers have brought their spending more in line with revenues.
Since 1995, service provider revenues have increased by 50%. Yet over the same period, equipment spending tripled, says Montgomery's Rezaee.
"We just went through a huge capital investment binge, and now we are going through a bust," says Rezaee, who holds Cisco and a small position in
Ciena
(CIEN) - Get Report
.
The market is still getting the message.
"Whatever optimism there was, it's rapidly fading," says
Lehman Brothers'
Steve Levy.
"Expectations will bottom this summer as everyone stops looking for some uptick this year," Levy says. "I think the market is coming around to the fact that 2002 will also be a difficult year." Levy has a hold on Lucent, and Lehman has no underwriting ties to Lucent.
Nortel's warning casts substantial doubt on Lucent's forecast of sequential improvements in quarterly financial results this year.
If Lucent is a fighter, it's woefully out of shape, going by revenue per employee comparisons. Even after its projected staff cuts, Lucent's revenue per employee will be 39% lower than Cisco's and 20% lower than Nortel's. This suggests Lucent still has a ways to go to bring costs and sales in line.
"We're looking for balance sheet improvements," says Levy. "That will be a way to see if they are getting their house in order. Their house was crumbling a few years ago, but you didn't see it on the income statement -- you saw it on the balance sheet.
"If there's going to be a turnaround, you'll see first on their balance sheet," Levy says.