Forget about the third quarter of 2001. Forget about the end of the year. Forget about that second-half recovery for networking-gear makers, because if Morgan Stanley Dean Witter is correct, the oft-cited and much-anticipated second-half recovery could be delayed until the third quarter of 2002.
According to a research note from Morgan analyst David Jackson, that second-half recovery for telecommunications-equipment companies might not arrive until the fourth quarter of 2001 or first quarter of 2002. In a worst-case scenario, it won't arrive until the third quarter of 2002. He downgraded
to neutral from market outperform. Jackson cited over 40 data points gleaned from conversations with carriers, systems vendors and component companies in his now bearish outlook on the industry.
In midday trading, JDSU dropped 11% to $17.05, while Nortel fell 8.6% to $13.36. Sycamore dropped 12% to $9.05, while Tellabs dropped 11% to $33.31.
Where some analysts such as
Jim Liang and
Salomon Smith Barney's
Tim Andersen, think the third quarter will mark a bottom for networking equippers, Jackson doesn't. He doesn't think that sales will flatten in the second half of the year, he thinks that they'll get even worse, with bad news continuing until the fourth quarter and little to no evidence of a recovery for quite some time.
"The depth of the current slowdown indicates the extent to which growth in the last few years was above trend," he wrote, capitalizing the entire sentence so investors wouldn't miss his point.
Jackson said that weak systems sales, high inventories and pricing pressure would continue to hurt networking gear sellers. Poor optical-systems sales at Nortel, which accounts for 29% of the optical-systems market, according to recent data, is just one of the reasons Jackson cited for the call.
In his view, Nortel's sales, especially in the high-margin OC-192 systems, are going to be weaker-than-expected -- something that bodes ill for JDS Uniphase and others that sell expensive components that plug into the OC-192.
Meanwhile, with demand for the systems down, he said that many of these companies -- like Nortel,
and long-haul system makers -- have high inventories and low demand for optical gear. He said he expects Nortel's inventory woes, something that CEO John Roth said would be a top priority for the company to reduce over the summer, would be a problem deep into the third and possibly fourth quarter. The same goes for Lucent and even if inventories do recover, the analyst said that companies have learned from their mistakes and won't be so sure to stock up on parts in the future.
"When the recovery in systems orders does occur," he wrote. "We expect systems vendors to attempt to avoid a rapid build-up of component inventories by attempting just-in-time inventory management."
Further exacerbating the inventory issue, according to Jackson, is the fact that prices have declined 25% for passive components in the past three months. He estimates that JDS Uniphase gleaned 55% of its first quarter revenue from passive components, yet another reason why he says, "JDSU could be hit harder in the continuing downturn."