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Cisco surges on hopes of turnaround

The company's shares surge after reports that corporate spending on networking equipment may be stabilizing.

Cisco shares surged Tuesday after a Wall Street analyst said corporate spending on networking equipment may be stabilizing.

Shares of the networking giant were up $2.20 to $20.00, or more than 12 percent, by market close.

In what was otherwise a fairly cautious note, Morgan Stanley analyst Chris Stix said networking products were the least likely to be cut by large companies, and 87 percent of U.S. businesses surveyed plan to upgrade their networks in 2001.

Stix said his firm questioned large North American companies about their planned spending on networking equipment, which is Cisco's bread and butter. He found that the market, while weak compared to a year ago, has stabilized, which is good news for Cisco, he said. Stix also noted that interest-rate cuts from the Federal Reserve are also giving corporations the confidence to spend.

But he added that while Cisco's North American business showed improvement, "we would need to stretch to get a higher valuation for Cisco."

A fair valuation for the stock would be around $18, Stix said, although "if we stretch, we can justify a valuation of $23," based on estimates of 25 percent to 27 percent revenue growth over the next five years.

Cisco is scheduled to report earnings next Tuesday. The company had issued a warning last month, telling investors it expected to see earnings per share to be in the low single-digit range and revenue to fall 30 percent from the second quarter.

The company also said it would take a restructuring charge of $800 million to $1.2 billion as part of a reorganization that includes layoffs of about 8,500 employees. Cisco will also take an additional $2.5 billion charge based on excess inventory.

Despite Stix's contention that some of Cisco's business has stabilized, he kept his rating on the stock at "neutral."

"We do not enjoy continually playing the role of wet blanket on Cisco, but if there is one thing we have learned from the recent pullback in this industry, it is that regardless of momentum, valuation is paramount in this end," he wrote.

Cisco's share price wasn't the only thing giving Stix pause. While North American spending is picking up, that only accounts for about a third of Cisco's business, he said.

And spending on network equipment by service providers, which accounts for another third of Cisco's business, is not seeing the same improvements. European spending is also weak, Stix said, and "it is unclear to us how long this weakness will continue."

"It would not surprise us to see the European recovery occur in (the fourth quarter), following the normal summer weakness in Europe," he wrote.

Signs that capital spending is stabilizing counter recent research on Wall Street.

Sanford Bernstein analyst Paul Sagawa recently issued a report predicting that capital spending by North American carriers will drop as much as 20 percent from 2000. And UBS Warburg analyst Nikos Theodosopolous recently downgraded several networking-equipment stocks, saying U.S. telecom companies will continue to cut back on spending in 2001.

Sagawa said it could take until 2002 before Cisco really sees a turnaround.