2HRS2GO: Comverse outlook turns off shareholders

COMMENTARY--Two negatives outweigh five times as many positives these days.

That's the message the market sent today about Comverse Technology (Nasdaq: CMVT), whose shares were down more than 10 percent at one point this morning after the company reported a strong fourth quarter and stuck with current consensus estimates for the current fiscal year.

At first glance, investors seemed pleased with Comverse, which gets most of its money from systems that communications providers use for services like voicemail, text messages on wireless phones and other "enhanced" services. The company has remained solid in a softening economy. Executives saw no reason to lower estimates for fiscal 2001.

Comverse shareholders responded immediately by driving CMVT higher in after-hours activity on the Island ECN. Several analysts gushed with congratulatory remarks on the conference call.

At least 10 investment firms came out with upbeat remarks this morning. "At last, a tech company with good news," declared Salomon Smith Barney.

The title of J.P. Morgan H&Q's note sounded like a CMVT press release, complete with exclamation points: "Comverse reports 27th consecutive upside quarter!!"

Other heavyweight firms that chimed in with positive news included Lehman Brothers, Credit Suisse First Boston and SG Cowen.

Comverse bulls would argue the stock deserves to trade higher than other companies because it is healthier than most of them. While other technology and communications companies have slashed estimates, Comverse has not, and does not expect to. The company's proponents see it as a "good defensive story," to quote SG Cowen analyst John J. Graves.

None of that mattered in the face of one big dose of valuation skepticism from Goldman Sachs.

Goldman downgraded Comverse to "market outperformer" from "recommended list."

Only one other brokerage, a relatively small outfit called Arnhold & S. Bleichroeder, echoed a similar level of doubt, and that firm already had a "neutral" rating on CMVT anyway, so it's no surprise.

No one thinks Comverse is doing a bad job. The company's confidence in current financial targets is admirable in such a lousy overall market.

But Goldman Sachs analyst Elan Zivotofsky was skeptical about Comverse ability to hold its stock price after the company's relatively cautious outlook; Comverse set a 2001 forecast in line with the current consensus estimate of $1.78 per share, after six straight quarters of raising annual earnings projections by 3 cents or more.

Some folks might wonder why people reacted so negatively, considering that a company like WorldCom (Nasdaq: WCOM) is rising today after reiterating previous predictions. In fact, Worlcom CEO Bernard Ebbers went out of his way to tell analysts not to raise their expectations.

But WorldCom investors were already braced for the worst, whereas Comverse's stockholders were hoping for more.

"In the context of the macroeconomic environment and the minimal guidance revision, we believe the share price could be weak near-to-medium term, given the current valuation, which in our opinion assumes significant EPS outperformance," wrote Goldman Sachs analyst Elan Zivotofsky.

As of 1:30 p.m. Eastern Time today, Comverse traded at $64.31, near its 52-week low of $62--but also a price-to-earnings ratio of 44, using the company's reported earnings of $1.47 per share for the past 12 months. That's far above the S&P 500's P-E ratio of about 24.

Viewed against that backdrop, Comverse's solid performance hardly matters to investors today. Analysts can praise the company's business model as being almost recession-proof, but everything is relative, and the reality is that the stock still trades far above the overall market.

Bears believe CMVT has merely gone from the top of an outrageously overvalued bubble to the top of a still-somewhat-overvalued market. From that point of view, CMVT will keep falling until it reaches the middle of a rational bubble.

It is a difficult argument to shed, and a few analysts who maintained "buy" or "strong buy" ratings tried to accommodate the skeptics.

In addition to today's 10 positive and two negative reports on CMVT, four brokerages maintained a "buy" or "strong buy" rating, while cutting the price target. A typical sentiment from the lukewarm quartet came from Morgan Stanley Dean Witter analyst David Raezer:

"We believe that the company could experience deceleration from January quarter levels due to slowing global wireless subscribers. We are maintaining our rating of Strong Buy and reducing our price target to $100 from $130 prior."

I'm not fond of that kind of analyst fence sitting, but his position is understandable. Comverse is a well-run company, with little competition in its core market and a business that can squeeze more revenue out of an existing subscriber base by offering new service.

But the market's foul mood can't be ignored. At the moment, Wall Street would rather punish conservatism than reward prudence.22GO>