Telecom downturn weighs heavily on Cisco

Cisco's shares hit a new 52-week low of $41.50 Tuesday, the sixth straight day the company's stock has dropped. Shares closed at $41.75. Overall, the networking giant's share price has been sliced nearly in half since its 52-week high of $82 in late March, despite Cisco executives' recent predictions of good financial results for the current second quarter and the rest of the fiscal year.

Wall Street analysts say Cisco has been hit hard by the recent disclosure in a Securities and Exchange Commission filing that the company set aside $275 million in a contingency account for possible losses during the first quarter ended Oct. 28, up from $75 million for the first quarter the previous year.

Most analysts say Cisco's decision to up its contingency reserves is not a sign that the company is taking huge financial risks. But they have tied the sum to the ongoing inability of struggling telecommunications service providers to pay their bills.

That has been a concern for investors lately, after Cisco competitor Lucent Technologies disclosed two months ago that bad loans to start-up service providers hurt its quarterly sales.

"As Cisco increases its share in the important service provider market, we would not be surprised to see its doubtful account allowance increase modestly," Merrill Lynch analyst Michael Ching said in a recent report. "However, we would also expect Cisco to manage the increased risk in a manner consistent with its superior financial execution."

Morgan Stanley Dean Witter analyst Chris Stix agreed. "We do not view this as a signal that Cisco is seeing increased payment risk," he said in a recent report.

Cisco representatives say the reserve is for minority investments, inventory and accounts receivable, a small percentage of which includes customers' inability to pay their bills. Cisco representatives downplayed the increase in reserves, saying it was raised proportionally to the increase in its volume of business.

Wall Street analysts blame Cisco's recent stock drop on investors who are fearful of a predicted slowdown in equipment sales to telecommunications service providers and on the increasing number of struggling start-up service providers that could hurt Cisco's results in the future.

Of the $275 million in the reserves, 5 percent, or $14 million, are for doubtful customer accounts. Last year, Cisco set aside $5 million for doubtful accounts.

Cisco has said it has taken a conservative approach by accounting for bills potentially going unpaid, nullifying the impact of such expenses on the bottom line.

Both Cisco and executives at competitor Nortel Networks have maintained that Lucent's problems with bad loans are isolated.

In October, Lucent announced increased short-term reserves for accounts receivable--such as unpaid customer bills--from $318 million last year to $501 million. Nortel raised its short-term reserves from $319 million last year to $400 million this year for the third quarter ended Sept. 30, and its long-term reserves from $284 million to $310 million.

Cisco, Lucent and Nortel representatives said they have separate reserves for potential bad loans to smaller service providers.

Some service providers, such as PSINet, ICG Communications and Covad Communications, have been struggling financially, leading Wall Street analysts to predict a slowdown in sales of telecommunications equipment.

News.com's Ben Heskett contributed to this report.