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Genuity cuts spending plans; stock soars

Shares storm up 29 percent after executives tell analysts that the company will scale back capital spending over the next three years and that they are seeing signs of improvement.

Genuity shares stormed up 29 percent Tuesday after executives told analysts that the company will scale back capital spending over the next three years and that they are seeing signs of improvement in its business.

Genuity shares moved up 69 cents to $3.08 in heavy trading. More than 6.8 million shares changed hands Tuesday, up 134 percent from their average daily trading volume of 2.9 million shares.

During its annual analyst meeting, Genuity revised its capital spending plans for the second time in the past six months, projecting network-equipment orders of between $4 billion and $5 billion through fiscal 2004.

Back in December, the Internet services company chopped its capital spending budget from between $9 billion and $11 billion to between $7 billion and $9 billion over the next three years, citing slower demand from large enterprise customers as well as the sluggish performance of the U.S. economy.

While Genuity shareholders were enthused by the spending cuts, major suppliers including Cisco Systems, Lucent Technologies, Redback Networks and Nortel Networks will surely feel the pain as yet another customer drastically reduces its spending plans for the foreseeable future.

"The bottom-line message here is that Genuity has completed a lot of its investment and won't be adding any new data centers anytime soon," said Thomas Watts, an analyst at Merrill Lynch. "That's good news for Genuity because any new revenue they generate will be at much higher margins. But it's not so good news for suppliers who are already cutting prices and have watched new orders all but disappear."

Most of Genuity's largest equipment providers actually gained ground in Tuesday trading, but analysts said those gains are more a result of the improved investment climate for technology stocks than a reflection of these companies' growth prospects.

Among Genuity's suppliers, Cisco shares moved up 61 cents to $23.18, while Nortel and Juniper Networks added 40 cents and 41 cents, respectively. Ciena rose $3.51 to $64.30, but Redback Networks fell $1.69 to $17.31.

"I've heard from a number of traders that a lot of the shorts are moving out of their positions right now," Watts said. "Plus, we're seeing broader buying from major institutions, and that's helping some of these telecommunications and equipment stocks."

Genuity's run-up comes just three weeks after it posted a third-quarter loss of $292.4 million, or 30 cents per share; drastically reduced its sales estimates for the fiscal year; and announced it would lay off 800 employees, roughly 12 percent of its work force.

"The large enterprise customers are revisiting their spending plans and no longer buying into the 'build it and they will come' theme," said Patrick Comack, an analyst at Guzman. "Customers are taking a longer time to build out their extranets or store their information on the Web, and Genuity is feeling it."

Comack points out that Genuity originally forecast sales growth in excess of 60 percent for the current fiscal year before lowering that target to around 40 percent. Following its first-quarter earnings report, the company scaled back its sales-growth estimate to between 16 percent and 18 percent.

During Tuesday's analyst meeting, Genuity said it augmented its sales force by 32 percent in the first quarter and that its number of proposals (essentially business pitches) are on the rise.

"They said they were finally getting into the game, so to speak, but now they have to work on winning some of those deals," Watts said.

Genuity expects to post sales of between $1.3 billion to $1.35 billion in the fiscal year, up from $1.14 billion in 2000. It anticipates a loss of between $1.30 and $1.40 a share.

"The capital markets have forced it to change its business model," said David Takata, an analyst at Gerard Klauer Mattison. "They may not say their business model has changed, but if they're cutting their capital spending in half, it's safe to assume they were expecting to have really big business by this time."

Analysts said that while Genuity has drastically reduced its capital spending plans for the next few years, equipment providers have been cutting prices in a desperate attempt to unload excess inventories.

"They may be reducing their spending by half for the next few years, but that doesn't necessarily mean they're only getting half as much equipment," Comack said. "There are some serious pricing battles going on out there, and services providers are benefiting."

Unlike other Internet services companies, Genuity can tap into the deep pockets of Verizon Communications, which holds about an 8 percent equity stake in the company, to build its network and services in the next few years.

Earlier this month, Verizon said it would provide Genuity with $2 billion of credit enhancements for a term of up to five years and increase its short-term credit facility from $500 million to $900 million.

Genuity, the former Internet arm of GTE, held its initial public offering back in June as a condition of the blockbuster merger of Bell Atlantic and GTE, creating Verizon Communications.

The IPO fizzled, and the stock eventually fell to a 52-week low of $1.20 a share in April.

The spinoff was necessary because Baby Bell companies such as Bell Atlantic, now reincarnated as Verizon, are forbidden from offering long-distance voice or data services, including Internet access, until they have opened their regions to competition. Bell Atlantic was allowed to offer long-distance services in New York, though not in the 12 other states or District of Columbia where it offers service.

Until Verizon opens those other markets to competition, the company will not be allowed to own more than 10 percent of the Genuity Internet backbone business. Once Verizon is cleared in the other mid-Atlantic states and the District of Columbia, it will then take an 83 percent equity stake in the company when its Class B shares are converted for common shares of Genuity.

"There's talk about Verizon possibly buying up the rest of the shares when they do receive clearance," Comack said. "But Verizon to this point says it wants Genuity to trade on its own. The fact of the matter is Genuity is their fiber-optic backbone and they're going to need to build that out even more in the years ahead."