Cisco Spins Its Wheels in Slowdown

The prospect of weak sales growth scares off investors. Meanwhile, rivals founder as well.
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A slowing pace at Cisco (CSCO) - Get Report jammed up the communications equipment sector Wednesday.

Shares across the industry skidded after the San Jose, Calif., maker of Internet traffic-management gear suggested the widely anticipated tech spending rebound is losing traction. Wall Street analysts stepped in with a series of downgrades, goosing a broad tech selloff.

After posting

solid fiscal fourth-quarter numbers Tuesday, Cisco chief John Chambers, in his self-appointed role as economist, warned that CEOs he has talked with recently have grown more cautious in their outlook.

The comments, along with surging inventory levels and higher projected operating costs, sent Cisco shares down 10% Wednesday. The selloff, which knocked the stock down $2.03 to $18.43, puts Cisco within a dollar of its 52-week low and leaves it more than 33% below its 52-week high.

Taking the ride along with Cisco were gear peers like

Juniper

(JNPR) - Get Report

,

Lucent

(LU)

and

Nortel

(NT)

, all of which dropped more than 3%.

In the wake of Cisco's earnings report and conference call Tuesday, analysts at UBS, Merrill Lynch and JPMorgan Chase swiftly issued downgrades. Cisco's in-line fiscal fourth quarter earnings and Chambers' tepid sales talk left little material to build a bullish case on.

"These guys aren't supposed to have ho-hum quarters," says JPMorgan Chase analyst Ehud Gelblum, who cut his rating to neutral from buy.

Gelblum lists a few concerns in his research note Wednesday, including inventory piling up 38% over the past three quarters. Tellingly, that's more than double the 16% revenue growth rate for the same period. On a conference call Tuesday, Cisco executives blamed some of the stockpiling on shorter lead times, meaning customers want orders filled faster. The problem with short order times is that Cisco must keep more gear on hand rather than ordering as needed from its suppliers.

To some observers, that indicates customers are starting to get the upper hand. Gelblum sees Cisco's wide 68% gross margins as one of the areas likely to suffer from a buyer revolt.

"If revenue was moving up sharply with a new product cycle, what happens on the balance sheet and behind the scenes wouldn't matter so much, in the near term," says Gelblum.

Analysts are big fans of spread sheets, and the numbers they've plugged in speak to some disheartening trends. One troubling development is that Cisco's costs are rising even as projected sales flatten.

In his downgrade of Cisco Wednesday, UBS analyst Nikos Theodosopoulos says sequential quarterly top-line growth will slow from a recent 7% to about 3% over the next four quarters.

Meanwhile, Theodosopoulos notes, the company expects operating expenses to increase about 3% sequentially in the current quarter, due to rising inventory and the hiring of 1,000 workers this year.

"We find the increasing level of operating expenses relative to revenue growth as a risk given the company's slightly reduced enthusiasm on corporate spending on the conference call," Theodosopoulos writes in a research note.

But not every spread sheet tells the same story. Some Wall Streeters still see plenty of upside.

"A small increase in IT spending combined with further market share gains, more service provider spending on IP, and Cisco's advanced growth initiatives should hopefully be enough to deliver low double-digit revenue growth for Cisco," CIBC World Markets analyst Steve Kamman writes in a note Wednesday.

Like many fans, Kamman sees Cisco as a well-oiled machine poised to hit the accelerator when the green flag waves over IT budgets.

But others, like Gelblum, are beginning to fear that Cisco is stuck in neutral until it can find a hot new product cycle.