The chill in the networking sector is spreading.
Recent days have seen a selloff among the telecom-equipment stocks that have led the
rally over the last year. Why? After two years of leadfooted capital-spending growth, phone companies and Internet service providers are easing off the telecom-equipment gas pedal, and Wall Street is taking notice. Tuesday has seen some of these stocks recovering, but even red-hot outfits like
are now 10% or more off their highs. Optical juggernaut
was off $2.31 Tuesday afternoon at $66.75, putting it nearly $10 below its Thursday close.
Depressed stock prices, declining revenue growth and limited access to cash are among the factors crimping the once free-spending service providers, which buy the gear that networkers make. While the massive spending on this gear fed a huge boom in networking stocks over the last two years, any pullback stands to be potentially devastating for these richly priced shares.
trends in several
stories over the last
With spending growth poised to recede, investors are starting to worry about valuations in the networking and telecom-equipment sectors. As a result, the last two weeks have seen sharp selloffs in the shares of these companies, from giants
to optical equipment start-up
and Internet gear pusher
. Indeed, the past two days have wiped billions off these company's valuations, as Wall Street begins to consider whether the golden age of telecom spending has passed on.
Another sign of a change: For the past several days, analysts who have traditionally been bulls on the telecom-services sector have been pointing to these pressures. They expect something -- capital spending, most likely -- to give at beleaguered big spenders such as
analyst Tod Jacobs, for instance, predicts a shakeout through consolidation and cuts in spending.
analyst Blake Bath pointed out in a report last week, network builders' recent bout of record spending has coincided with a period of dramatically falling long-distance revenue. Bath
predicts that the industrywide ratio of revenue to spending will hit an unsustainable 2:1 next year. Inevitably, service providers will need to squeeze money out of equipment investments, he says.
Bath says the large-cap telcos will hit their peak spending next year and "then it will ease off dramatically from there." Another dyed-in-the-wool bull,
Credit Suisse First Boston's
Dan Reingold, echoes that point.
"My numbers for 2001 show a deceleration in the rate of capital expenditure growth," the analyst says. "There was over 30% growth this year in cap ex, and about 20% in 1999, and next year we see a deceleration to 10% growth."
Of course, Reingold sees this as good news for service providers that can stop bleeding money and start selling services. And, for the equipment makers, he says it's not exactly the end of the world.
"This is a peaking process, if they spend $100 billion this year and $110 billion next year, those are big numbers and that's a lot of equipment," says Reingold.
Indeed, and spending is likely to continue to be lush even if growth slows. As telecom service companies have raced to build a bigger Internet, the networking industry has enjoyed two years of phenomenal outlays. This year, equipment spending is expected to reach $115 billion in North America, according to
Credit Suisse First Boston
But signs of strain are starting to show already. Williams Communications, which is in the process of building the nation's third-largest fiber-optic network, has recently
found cash a little harder to get a hold of. Williams had to liquidate its shares of optical switch maker
to raise cash, and says it will also sell
and optical gear specialist
shares to raise more money when possible.
This has brought added
pressure to the optical equipment makers that count on new fiber-optic network builders such as Williams,
, and Qwest as customers and also investors.
As competition increases and funding tightens, these upstart network builders and their suppliers are the most vulnerable.
"The emerging companies' spending has been far less productive than one might expect in terms of the revenue they have been able to generate on it," says Lehman's Bath. What makes matters worse for the new entrants and would-be start-ups is that a roster of tracking stocks and spinoffs are scheduled to hit the market. Those new issues will hog available investment money, toughening the going for less-established players, says Bath.
"A big part of me hopes I'm wrong on this," says Bath. But the evidence points to further pullbacks in these stocks.