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The Starting Line: Cisco rumor mill runs amok

Financial troubles for the company's peers have stirred up plenty of speculation about its fourth-quarter earnings report, which won't be released until August.

What do you get when 360networks refuses to make its bond payments and Juniper Networks and Nortel Networks issue profit warnings?

A lot of rumors about Cisco Systems' fourth-quarter earnings, which won't be reported until Aug. 7. Cisco's quarter won't close until July 31, but that hasn't stopped Wall Street's rumor mill from going into overdrive.

It's worth noting that all of the rumors circulating about Cisco are unsubstantiated. In fact, for every analyst or trader that floats a Cisco theory, there's another one ready to shoot it down. For the record, a Cisco spokeswoman who has been pelted with questions almost every hour since Nortel issued a profit warning Friday said the company won't comment on rumors and speculation.

But that response doesn't stop the questions from coming. Will Cisco issue a profit warning for the fourth quarter? Will it take charges to write down the values of acquisitions made in 2000? Will the company stick to its long-term growth rate of 30 percent to 50 percent? Will it make an acquisition?

The chatter is deafening. A chain of industry events has Wall Street itching to connect the dots between Cisco and the woes of its rivals.

First, Juniper said it would report second-quarter profits well below Wall Street estimates. The company also said it would give walking papers to 8 percent to 9 percent of its employees.

A week later, Nortel announced it would miss earnings and revenue estimates by a wide margin, lay off an additional 10,000 workers, and report a net loss of $19.2 billion because it was writing down good will associated with acquisitions.

Toss in the troubles of 360networks, a Cisco customer that said it won't make interest payments on its debt--as well as the almost daily reports about weak telecommunications spending --and there's a lot to worry about.

The speculation illustrates just how jittery investors have become about Cisco, once a Wall Street darling. The company's stock has lost billions of dollars in market capitalization and is the biggest loser among the world's 50 largest stocks through June 14, according to J.P. Morgan Chase.

Last week, Cisco shares were the second-biggest loser behind cell phone maker Nokia, which saw shares fall after its own profit warning.

The days of Cisco's free pass on Wall Street are history, especially considering the company's disappointing third-quarter results, when it reported a net loss of $2.69 billion including a $2.25 billion inventory charge.

Most analysts say it's too early to guess how Cisco's fourth quarter will work out. On the plus side of the ledger, the company derives the majority of its revenue (more than 60 percent) from corporate customers. On the minus side, Cisco can still take its lumps as telecommunications companies slow spending. Analysts said Nortel's June quarter imploded because 90 percent of its revenue comes from telecommunications carriers, which aren't spending the way they used to.

"The real difference here is that Cisco gets a lot of its revenue from the enterprise," said Matt Barzowskas, an analyst at FAC/Equities. "Cisco may not be as ugly as you'd think because they're more diverse."

According to Credit Suisse First Boston analyst Lissa Bogaty, it's possible that Cisco could fall short of sales estimates but meet its profit targets because of cost cutting.

"Several resellers of Cisco equipment in the U.S. are reporting stiff competition for deals," she said in a research note, adding that discounting is rampant. "To us this suggests desperation to close business this quarter as demand fails to materialize."

Michael Cristinziano, an analyst at Gerard Klauer Mattison, said Cisco is likely to hit its financial targets but noted that estimates have dropped sharply. If Cisco meets its targets, it's "mainly because of its enterprise business," he said.

Cisco is expected to report a profit of 2 cents a share on revenue of $4.33 billion, according to First Call.

Analysts also said they expect Cisco to stick to its mantra of 30 percent to 50 percent long-term growth, but noted that the company will be gaining from a much lower sales base.

Another key concern swirling around Cisco is whether the company will unveil more charges. Nortel took $12.3 billion in goodwill write-downs related to the acquisitions of Alteon WebSystems, Xros and Qtera.

Cisco completed 22 acquisitions in 2000, but most of them cost less than $1 billion. Nevertheless, the company could readjust its goodwill accounting for the April 2000 purchase of Arrowpoint Communications, a deal valued at $5.7 billion at the time, analysts said.

Tad LaFountain, an analyst at Needham & Co., said comparing Cisco and Nortel in terms of potential goodwill write-downs is like comparing apples and oranges. He noted that Cisco ended its third quarter with $4.95 billion in good will on the books; Nortel entered 2001 with $19 billion.

Cisco also has more than $5 billion in cash, much more than Nortel. "Is Cisco in the same class as Nortel and Lucent? I don't think so," LaFountain said.