Cisco, Lucent Offer Shelter From Net-Sector Storm

The two communications-equipment stocks have provided stability in the turbulent world of the Internet.
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SAN FRANCISCO -- Providing safe havens in the Internet maelstrom, shares of Cisco (CSCO) - Get Report and Lucent (LU) have been largely unruffled by the exodus of capital from high-profile Net plays in recent weeks.

Internet stocks have taken quite a clubbing since the

Nasdaq Composite's

high-water mark on April 26.

eBay

(EBAY) - Get Report

is still down 17% from its high this year, and

Amazon.com

(AMZN) - Get Report

is off 42%. The same goes for Internet bellwethers

Yahoo!

(YHOO)

, down 27%, and

America Online

(AOL)

, down 26%.

By contrast, the two communications-equipment stocks corrected mildly before joining Wednesday's recovery. Cisco, the leading builder of computer-network equipment, is down 7% since April 26. Lucent, the largest supplier of gear for telephone networks, is off 10% in the past month. The Nasdaq Comp has fallen 9%.

Meanwhile, at the Oasis
Cisco and Lucent vs. TheStreet.com Internet Sector index

Even after the market's overall bounce Wednesday, money managers expect this division in stock behavior to continue.

The correction was "vicious, but not surprising," says Curt Rohrman, portfolio manager of the

(USSCX) - Get Report

USAA Science and Technology fund, which holds both Cisco and Lucent. "You're going to have big swings

in Internet stocks, as people go manic depressive on them."

One reason for the stability is that even-keeled institutional investors hold a larger stake in these stocks: They own 48% of Lucent shares and 64% of Cisco shares, according to

Market Guide

. By comparison, institutional ownership of

Infoseek

(SEEK)

, eBay and

priceline.com

(PCLN)

is 20%, 11% and 0.2%, respectively. These Net stocks have been dominated by trading among individual investors.

"There are real buyers with real money to buy Cisco. I'm not sure you can say that about these second- or third-level Internet companies," says David Brady, portfolio manager with

Stein Roe Mutual Funds

, a Cisco investor.

And unlike the e-commerce and portal plays jostling for control of their markets, Cisco and Lucent shine as clear leaders in an industry that has already seen its share of consolidation. Next month, Lucent expects to close its acquisition of

Ascend

(ASND) - Get Report

, currently the No. 2 computer networker.

While Net commerce and portal companies have seen many mergers in recent months, few expect the trend is anywhere near a climax. "People are not quite as convinced of who the winner is going to be," says Rohrman. America Online appears to be a winner, he says, but it's not as clear a leader as Cisco.

Rohrman has invested in Internet stocks such as AOL, Amazon and priceline.com, treating each as a "zero-coupon bonds" that promise huge potential returns in a few years -- and plenty of price volatility in the meantime.

"These are longer duration instruments," agrees Phil Treick, portfolio manager of the

(TPAGX)

Transamerica Aggressive Growth fund. His money-management firm owns both Cisco and Amazon. Treick is concerned, however, that retail investors are flipping Internet stocks for quick gains, which can make for shaky quarterly performance.

Brady at Stein Roe is willing to own AOL -- overpriced by any conventional measure -- partly because he feels he can trust more of its constituents. AOL rests on a 62% base of institutional owners, nearly equal to that of Cisco, and as a member of the

S&P 500

, it attracts index-fund managers as well.

But fund managers point to another crucial difference between AOL and Cisco. Even in these heady times, you can be rational when it comes to valuing Cisco. Brady, for one, peers far into the distance and estimates that Cisco will grow its earnings 25% to 30% annually to $5.60 in 2005. Put a price-to-earnings ratio of 25 on that, and Cisco shares would be valued at 140 compared to 109 1/8 Wednesday. "I still think you can make money on it."

Meanwhile, AOL -- even by Brady's elastic measures -- is fully valued.

"I'd be more inclined to buy Cisco than AOL."

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