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Analyst, CEO comments roil Cisco shares

Shares of the networking giant take a hit after pessimistic comments by an analyst, and CEO John Chambers describes this quarter as "challenging."

Shares of former highflier Cisco Systems hit some turbulence Wednesday after an analyst issued a pessimistic report and the company's chief executive described the current quarter as "challenging."

A CIBC World Markets analyst said in a research note that the networking giant's glory days may be over. In response, Cisco shares tumbled more than 8 percent in early trading before recovering.

A few hours later, however, the shares once again dipped some 8 percent after chief executive John Chambers described the company's current second fiscal quarter as "more challenging" at a Morgan Stanley Dean Witter investment conference in Phoenix. Yet the stock recovered again, closing the day down 88 cents, or about 2 percent, to $36.25.

John Chambers The one-two punch of the analyst report and Chambers' comments resulted in record trading volume for Cisco shares: At market close, more than 212 million shares changed hands. (Click here for current stock price.)

Chambers seemed to send mixed signals on the tech economy and its effect on Cisco. "Is the economy slowing? Absolutely," he said.

Chambers also noted that Cisco wasn't immune to a slowdown, which occurred "at a faster pace than people realize." He said the second quarter will be "a little more challenging." In doing so, Chambers seemed to be setting up Wall Street to be ready for a slowdown in revenue growth. Last quarter, Cisco sales grew 66 percent.

Chambers' comments followed a bullish report by the company to the investment community in December, when he suggested the company was positioned to "break away" from competitors and could continue to thrive amid a downturn in the market.

That followed an increase in projections for the company's 2001 fiscal year in November.

"Let me say this directly: Our customers' business is slowing, not our business with customers," said Chambers, who indicated that the Federal Reserve should have cut interest rates at its December meeting. "They describe it in the same way: The economy was like hitting a wall or like hitting the light switch."

But Chambers returned to his familiar mantra in projecting long-term success for Cisco, saying that the company will grow at a 30 percent to 50 percent clip.

That's not to say there won't be speed bumps in capital spending, he said. "We are not immune, but we won't be as affected as some segments of the IT (information technology) community," he said.

"If we can execute as we have in the past, I'm more comfortable about our future than we've ever been," he said.

Cisco a bloated giant?
CIBC World Markets analyst Steve Kamman in a research note Wednesday downgraded Cisco, along with several networking equipment companies including Juniper Networks, which was dropped to a "buy" rating from "strong buy," and Redback Networks, which was cut to "hold" from "buy." Lucent Technologies was upgraded to "buy" from "hold."

Kamman's downgrade of Cisco to "hold" from "buy" wasn't new, but his take that the company will become a bloated giant was notable. Based on short- and long-term concerns, Kamman said the company is fulfilling the prophecy of Clayton Christensen's book "The Innovator's Dilemma," where dominant companies falter because they cling too long to a business model based on sustaining technologies rather than disruptive ones.

The gist of Kamman's thesis is that Cisco won't be able to continue its rapid acquisition pace to keep a technological edge. "All acquisition-driven strategies inevitably must end," he predicted.

Not all analysts agree. In a research note last week, Lissa Bogaty, an analyst with CS First Boston, said Cisco's quarter is "in good shape." Coupled with a cut in interest rates that should boost capital spending, the quarter means Cisco should be able to "continue its traditional growth rates," she said.

Bogaty projected that Cisco shares should trade in the $50 range. "We believe that the stock can move up to the low 50s near term as investors feel comfortable and project this multiple onto next year's earnings," she said. "We think it will move above this range as Cisco proves that it is less cyclically sensitive than some are worrying about."

Kamman said it's doubtful that Cisco can continue its growth.

"We believe Cisco will not make consensus revenue estimates in fiscal year 2002 and expect it will no longer be able to rely on appreciating stock as a currency," Kamman stated in his report. He said 30 percent to 40 percent revenue growth is mathematically unlikely, and he expects a long-term revenue growth rate of 20 percent to 25 percent from now on.

Kamman said Cisco is likely to see a slowdown during the next six months. He also said the company's failure to develop a new type of network interface card and its loss of a 30 percent share to Juniper do not bode well.

He recommended that investors wait the transition out. He said Cisco will stay dominant in the enterprise market but may falter in the service provider business.

He also said the company is not "well positioned to meet an expected tsunami of changes in the telecom market," because its "end-to-end" strategy and "intelligent network" vision run counter to fundamental trends in the industry.

Kamman described a coming telecom shakedown in which carriers may cut costs by building lower-cost network designs, rather than increasing revenue by adding new features and services as Cisco expects them to. Kamman also noted a trend toward specialized service providers that will to look to buy from equally focused equipment suppliers.

A so-called brain drain will also continue as Cisco loses high-level executives, Kamman said. The company may reprice options to keep employees.

The analyst painted a grim picture for the company; he expects it will "either increase cash compensation or option grants to try and stem the tide (creating) a strong negative feedback loop, with repricing and cash grants spurring further stock drops, leading to further departures."

Fiorina onboard
In related news, Cisco said Wednesday that Hewlett-Packard's chief executive, Carly Fiorina, has joined its board of directors.

Fiorina was elected to the board Tuesday, a day after it was disclosed that she gave back $625,000 of her HP salary because the company missed earnings targets.

She will be the 13th member of the Cisco board. Another recent addition to the board was Jerry Yang, co-founder of Yahoo.

HP and Cisco have partnered on a number of fronts in the past, including home networking and Internet-based software initiatives.

News.com's Erich Luening, Scott Ard, Ben Heskett and staff writer Ben Charny contributed to this report.