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THE DAY AHEAD: Cisco tips the react-o-meter

COMMENTARY-- With our reader react-o-meter running amok, it's time to dip into the mailbag to address reader comments from last week. The favorite topic was Cisco Systems by a landslide.

When Cisco was making everyone rich, readers were fat, happy and apathetic. Now Cisco shares are in the tank and conspiracy theories abound and so do flaming e-mails--some of which seem to be directed at me.

So here's a look at the issues.

The inventory game
In a column last week, I noted that Cisco gave a boost to contract equipment stocks after it said it would take a $2.5 billion inventory write-off. There were fears that contract equipment makers would get stuck holding inventory--something that wasn't possible under Cisco's contractual obligations.

In a tongue-in-cheek manner, I noted Cisco was running for partner of the year. It obviously wasn't tongue-in-cheek enough even though I tossed in some fictional dialogue from Cisco CEO John Chambers.

The point? Cisco had to take the write-off because it was responsible for its inventory glut. Cisco could have given its outsourcing partners a tough time, but it is so dependent on companies like Jabil Circuit and Solectron that they could have put the networking giant out of business over an extended flap.

Nearly all the e-mail I received on the inventory topic came from analysts. One analyst involved with Solectron's 1989 initial public offering noted the following:

    "There was never any question as to who was responsible for the inventory of parts, work-in-process, and finished goods ordered by electronic OEMs (original equipment manufacturers) from their EMS (electronic manufacturing services) providers, except in the minds of those who do not know the EMS industry well or in the minds of those who were short the EMS stocks and who were spreading rumors about EMS inventory risks in a mostly successful effort to drive the stocks down...

    "EMS providers' contracts with their customers are very clear on who owns that inventory. As Jabil Circuit said in its April 5 analyst meeting, that responsibility is not an 'understanding' or an 'industry practice.' It is a binding contractual obligation. There was never any question as to who would be responsible for the inventory...

    "Cisco did not take the inventory writedown because it wanted to help the stock prices of its suppliers. Cisco took the writedown because it was contractually obligated to do so. Moreover, if Cisco had not honored its contracts, those 6 companies would have immediately cut Cisco off, which would have put Cisco out of business. That is the reality...

    "How could the EMS companies afford to stop doing business with the company that is, collectively, their largest customer? Simple. The EMS companies make products for Cisco's competitors too, who would have picked up all of Cisco's business. There is no question that the balance of economic power in this matter lies with the suppliers...

    "Cisco has been more open than the others, which is good. Cisco has been much more open about its outsourcing, in general. It would have been even better if Cisco had said how much of its inventory writedown had been previously on the books of its EMS suppliers."

The shareholder suit
Point out that shareholder lawsuits are often bogus, and you get a bunch of investors burned by stocks that stink yelling at you and lawyer bashers cheering you on.

A surprising number of people think that the shareholder lawsuit against Cisco is warranted. They point out that Cisco execs dumped shares at the peak (don't they all?) and were annoyed because they didn't. One reader said I was just defending Cisco because I was a shareholder. For the record, our policy is that reporters don't own tech stocks that they write about. If we did we'd be seriously lacking in the credibility department.

Here's a sampling of e-mail on the shareholder suit:

    "I am sick and tired of these (lawyers) feeding on these recession plagued companies claiming that they are on the side of shareholders when their fees soak up most of any proceeds from any settlement. Law firms don't seem to be aware that the whole market has tanked and that both credit risk and order cancellations rise significantly during recessionary times like this. They just make things worse for shareholders by taking management off the job and putting them in the courtroom," said a reader who also suggested the Federal Reserve screwed everything up.

    "I hate lawyers as much as anyone else however your arguments against the class action suit are childish. Long position bite you? No response required or particularly desired," said another reader, who didn't get a response.

    "Mostly I would agree with you about class-action lawsuits and party plaintiffs that milk companies for not living up to their stated earnings, but in this case I disagree with you entirely. Cisco Systems should have warned last fall that it may not make its February numbers. Instead, it coached investors that the quarter would be merely "challenging." After seven years of not missing a quarter, a missed quarter would be a disaster and Chambers knew it! That's when most "old faithful" shareholders realized that trouble was in the air and sold. If we had known there was a chance that the quarter would be missed, we could have at least used that objective information in balancing whether the greatest salesman on 'planet internet' (Cisco Systems 1995 slogan) was merely inspiration. We did not get that chance until the stock was down 60 percent from it's insane high.

    "For once, the class action lawsuit has enough of a legitimate basis (and I'm a defense attorney during the day so I'm no lover of litigation) to go forward in an effort to ferret out just what made this company's wheels fall off," said a reader who noted that he sent his "opinion by way of a Cisco Systems router."

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