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Extreme plunges on downgrade

The company's shares fall more than 26 percent after an analyst says estimates about growth in the switch-making industry have been grossly overstated.

Extreme Networks shares plunged more than 26 percent Monday after an analyst said estimates about growth in the switch-making industry have been grossly overstated.

Shares in Extreme, which makes switching systems for use in carrier and enterprise networks, were off $5.95 to $16.50 by market close. Competitors also fell on the news, bringing CNET's networking index down 0.58 percent.

Morgan Stanley analyst Christopher Stix downgraded the stock to "neutral" from "outperform" Monday. The analyst said his problem isn't with the company's current quarter, which appears to be on track. First Call predicts the company will bring in 8 cents a share for its first quarter, which ends in September.

The problem is a much larger one: "We believe the industry forecasts for Layer 3 switching are too aggressive, based on assumptions of modest price declines," Stix wrote. Speculation about a price war among telecommunications companies has already had an effect on shares.

Last week research firm Dell'Oro Group released its estimates for the Layer 3 networking switch market, predicting it will have 20 percent growth in calendar 2001, followed by 28 percent growth in 2002 and 32 percent growth in 2003. A Layer 3 switch is a network device that forwards traffic at high speeds.

"Over the next two years we believe that the Layer 3 switching business can grow in the high-teens to 20 percent range," wrote Stix, who said Dell'Oro didn't account for the price declines that should be expected.

As for Extreme, Dell'Oro's results showed the company did relatively well, though revenue in the market fell by 6 percent.

CIBC Oppenheimer analyst Steven Kaman noted that Extreme was among the companies that increased their revenue and market share. Enterasys Networks, Foundry Networks and Riverstone Networks did likewise. Only Cisco Systems, which saw switch sales down 5 percent, and Nortel Networks, which had sales plunge 45 percent, were on the decline.

Though Extreme, having increased sales by 4 percent, may be benefiting from its competitors' losses, Stix warned that as Cisco attempts to gain market share, price competition could heat up. The analyst has therefore lowered his estimates for calendar 2002 earnings. He now expects Extreme to see revenue growth of 27 percent, as opposed to 39 percent.

On the bright side, Extreme's new chief financial officer should "keep expenses in check, leading to expanding operating margins through the period," Stix said.