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Cisco shares stumble on downgrade

Shares of Cisco Systems (Nasdaq: CSCO) fell 11 percent to a 52-week low Wednesday after Merrill Lynch downgraded the stock on concerns about slowing capital spending.

In early trading, Cisco was off 4.56 to 37.18. Merrill analyst Michael Ching was the latest Wall Street analyst to voice concerns about Cisco. Slowing IT spending along with capital spending cuts from telecommunications providers are hitting next-generation networking equipment makers with a double whammy.

Foundry (Nasdaq: FDRY) was among the latest equipment makers to take a hit, as shares fell 50 percent after the company issued a profit warning. Shares of networking companies Sycamore Networks (Nasdaq: SCMR) and Juniper (Nasdaq: JNPR) also traded lower Wednesday.

Ching's thesis is that Cisco can't be immune from the slowdown forever. He downgraded his "intermediate term opinion to "accumulate" from "buy" and added that Cisco was being downgraded for "guilt by association."

However, Ching didn't cut his revenue or earnings estimates for the company, but said Cisco wasn't likely to pull off upside surprises given slowing demand for next generation switching products, pricing pressure and slowing corporate IT spending.

Ching gave the following reasons for the downgrade:

  • Slowing ISP spending: Citing Foundry's profit warning, Ching said Cisco could take a revenue hit. Next-generation switching products represent 20 percent of Cisco's sales. A host of telecommunications firms have cash problems. Cisco also recently set aside reserves to cover customers that can't pay the bills.

  • Price pressure in the enterprise market: A recent Merrill Lynch survey raised some concerns about falling prices. "The data suggests we could be starting to see a little more pressure on prices of data networking equipment," said Ching. Specifically, Merrill found that 17 percent of managers believe prices are down more than 10 percent from last year. An August survey found only 4 percent believed that prices were falling more than 10 percent.

  • Macroeconomic issues: The economic slowdown will "prompt investors to become increasingly concerned about a deceleration in corporate IT spending in general," said Ching. The enterprise and small and medium business market accounts for 65 percent of sales.

    In the long run, Ching said Cisco remains one of his top picks, but said recent economic concerns could put a dent in the company's pricey market capitalization.

    Ching isn't alone with his worries about Cisco. In another research note Wednesday, ABN AMRO analyst Kenneth Leon noted that the "game has changed for both telecom equipment companies and investors as market conditions have shifted from cloudy to rain."

    In the current environment investors will refrain from valuing companies on forward sales and shift to conservative benchmarks like cash flow and earnings, he said.

    That's bad news for Cisco and its rivals. Despite its recent tailspin, Cisco is still carrying a price-to-earnings ratio of 101.