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Analyst: Whither telecom spending?

As telephone carriers struggle with debt and financing issues, things could go from bad to worse for telecom equipment makers, according to an analyst.

As telephone carriers struggle with debt and financing issues, things could go from bad to worse for telecom equipment makers, Sanford Bernstein analyst Paul Sagawa said Friday.

Capital spending by North American carriers will drop as much as 20 percent from 2000, Sagawa predicted. That could have a major effect on companies such as Cisco Systems and Nortel, makers of much of the network gear used by telephone companies.

Sagawa, who was among the first analysts to warn of the telecom equipment slowdown last September, said the spending cutback could stretch into 2002, dropping by more than 5 percent "as carriers struggle to gain break-even cash flow in an environment of continued tight capital availability."

He faulted "an orgy of overinvestment plus intense price competition," which "yielded a bonfire of negative cash flow for carriers," saying that North American carriers spent more than $50 billion in capital in 2000, as capital expenses rose to 35 percent of sales.

Now, as the capital markets dry up, larger carriers will cut back on spending. And smaller companies, as well as alternative long-distance carriers, which accounted for 30 percent of industry spending in 2000, could simply go bankrupt.

"We believe many, if not most, of these carriers--including alternative long-distance carriers--will be forced to seek protection from creditors," Sagawa wrote. "Not only will this effectively shut down capital spending from this previously high growth sector, but the resulting asset sales to established carriers will squeeze out additional spending on new equipment."

The cutbacks have already made their presence felt at equipment manufacturers; Corning, which makes optical-fiber and networking components, and flat-panel displays, issued its third warning in three months.

"We do not believe that communications equipment spending growth will top 15 (percent per year) in the foreseeable future, much less approach the 2000 peak of more than 35 percent," Sagawa wrote. Sagawa isn't the only analyst to raise a warning flag on telecom equipment stocks. UBS Warburg analyst Nikos Theodosopoulos downgraded the entire sector earlier this week, citing similar concerns about carrier spending.

He lowered ratings on ADC Telecommunications, Avici, Cisco, Ciena, Juniper Networks, Nortel Networks and Tellabs from "buy" to "hold."

Sagawa said he could only issue positive recommendations on Nokia and Palm, which he rated "outperform," saying that each of those companies had a "sustainable competitive advantage in different aspects of the wireless-device market."

He also kept "outperform" ratings on Lucent Technologies and 3Com, saying that those companies could turn in a positive surprise if they're able to slow down their spending.

But Sagawa was not optimistic about Cisco's and Nortel's future. He said it could take until 2002 before Cisco, which issued a profit warning earlier this month, began to turn around. As for Nortel, he warned that the stock could "test its lows several times over the next few quarters until cost cutting begins to deliver positive earnings."