2HRS2GO: No reason to leave ECI if you're in it

4 min read

I hate to sound like an apologist for a company that just walloped investors with a massive earnings warning, but...

If you're long on ECI Telecom (Nasdaq: ECIL), nothing said today should change your mind.

Have an opinion on this?

The market spiked ECI with a piledriver today after the Israeli maker of communications systems said it would miss analysts' fourth quarter estimates by 13 to 16 cents per share, or as much as 26 percent below First Call's consensus figure of 62 cents. Shares of ECI immediately plunged as much as 29 percent on the news, though the stock has recovered slightly.

ECI was a Wall Street dog for most of 1999, as the stock shed 44 percent of its value between February and October, despite a 48 percent year-over-year improvement in the company's revenue for the first nine months of the year. You can blame much of the decline on the fact that ECI doesn't get much of its business from U.S. companies. Wall Street talks a big game with international investment, but in the end, Nasdaq investors are as home-focused as anyone else.

But since October, the ECI shares were staging a modest recovery, perhaps because of the company's rising business in hot investment markets like wireless, broadband and optical networking.

This morning news brought that to a screeching halt, which is too bad. Because assuming ECI executives are right, the fourth quarter shortfall shouldn't be a recurring problem.

Here's what it comes down to:

ECI signed a pact in November to develop systems for a wireless local loop for a large Asian government that company executives refused to identify. The roughly $50 million, 2-year contract requires the government to obtain certain financing documents before ECI can formally recognize revenue. The government didn't get the documents done in time. ECI was forced to put off recognizing revenue even though the work was done.

That resulting $14 million sales shortfall translates into a bottom line hit of 9 cents per share.

The rest of the earnings shortfall traces back to lower gross margins (which in theory is bad) caused by an unexpectedly rapid growth in ADSL-related sales (which is very good), and higher marketing expenses. The expenses are a one-time event, said company president and incoming CEO Doron Inbar.

That's it.

Actually, judging by the umpteen bazillion different variations of "What the hell happened with the contract?" asked by analysts and money managers during this morning's conference call, the shortfall wasn't as easy to explain as I make it sound. I certainly didn't get it the first time around, though that may be because I had a tough time understanding ECI executives over the phone.

But hopefully you get the idea.

This is not a recurring problem. ECI expects to recognize the revenue at some point this year. And this year the company is focusing on its high growth areas while phasing out other businesses.

"Obviously, the shortfall is disappointing," says Robert Reitzes, senior managing director for Bear Stearns. "But what made me feel good was the way business looks coming up. ... It (today's news) is like your mother feeding you medicine. You don't like the taste of it, but it's good for you."

More than anything, today's ECI pummeling demonstrates what happens when you have few friends on Wall Street. Contrast it with the relatively mild downturn for Dell Computer (Nasdaq: DELL), which announced an earnings shortfall of roughly the same as ECI's, on a percentage basis.

Analysts rushed to Dell's defense and most investors refused to bail on their beloved PC maker, despite a second straight earnings disappointment combined with revised targets of lower growth going forward.

On the other hand, ECI until now had never missed estimates (granted, often it only meets them) in a decade of public trading on the Nasdaq. The company sees faster top line growth ahead, which is pretty good for an outfit that's about to report 1999 sales nearing $1.2 billion. And ECI plays in markets expected to see far greater expansion than Dell's computer hardware field.

Perhaps today's warning was an excuse to take ECI profits after the stock's climb over the last couple months. Ok, reasonable enough. But now the bad news is out, so why worry?

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