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ANALYST WATCH: Investors edgy ahead of Cisco numbers

COMMENTARY--After twice guiding analyst sales estimates lower this quarter, Cisco Systems will finally tell investors just how much the slowing economy has cooled its blistering growth rate when it reports second-quarter results next week.

Judging from analyst reports issued in recent weeks and the continued deterioration in Cisco (Nasdaq: CSCO) shares--down from a 52-week high of $82 in March to around $36 this week--one could easily get the impression the network-equipment giant is in danger of missing estimates this quarter.

First Call Corp. consensus expects Cisco to earn 19 cents a share on sales of $7.22 billion.

With young upstarts such as Avici (Nasdaq: AVCI) and Juniper Networks (Nasdaq: JNPR) cutting into its core router business and a rapid deceleration in equipment orders from major telecom and service provider customers, Cisco finds itself in the once-unthinkable position of having to defend its valuation for the first time in its 11 years as a publicly traded company.

The days of 50 percent or 60 percent year-over-year sales growth are over for Cisco, just as they ended for IBM (NYSE: IBM), Microsoft (Nasdaq: MSFT) and every other technology bellwether that managed to scrap its way to the top of the IT food chain.

But even if sales slow to 25 percent to 30 percent in the coming years, most analysts believe that will be enough to keep Cisco as a staple in every major mutual and technology fund for years to come.

“They’ll make this quarter,” said William Becklean, an analyst at SunTrust Equitable Securities. “John Chambers has twice guided us down so we know the business is slowing right now. But I still rate it a strong buy.”

Becklean said he expects Cisco to offer up a very conservative outlook for the third quarter and the rest of the fiscal year.

Much has been made of Juniper’s impressive growth in the core routing business in recent quarters. By beating Cisco to the punch with its 10-gigabit routers, which moves data at 10 billion bits per second, Juniper was able to work Cisco honchos into at least a temporary sweat.

Cisco responded this week when it rolled out its own 10-gigabit offerings--with the sexy monikers 12410 and 12416--for customers such as AOL Time Warner (NYSE: AOL), Sprint (NYSE: FON) and AT&T (NYSE: T).

These developments have calmed the nerves of investors worried that Cisco is slowing losing its stranglehold on the high-end router market.

According to market research firms, Juniper has gobbled up about 30 percent of this market leaving poor Cisco with only 69 percent.

Despite all the hand-wringing about the slowing economy and, specifically, information technology spending, this core routing business will to continue to grow at a healthy clip as Internet traffic continues to accelerate.

Various market research firms peg worldwide sales of high-end routers at around $12 billion by 2003.

But even the slightest hint of a chink in the armor at Cisco sends some investors into a panic.

“The inroads Juniper has made in this business has been an issue for more than a year,” said Michael Perica, an analyst at Gruntal & Co. “This is nothing new. Juniper’s made some impressive gains but that’s not going to continue going forward.”

Analysts universally agree that Cisco is still playing catch up to Nortel Networks (NYSE: NT) in the fast-growing optical switching market. Despite some expensive acquisitions in this area, Cisco hasn’t been able to make the impact that investors would have expected from a company with its vision and resources.

Investors must be scratching their heads after watching the stock’s precipitous decline in the past 10 months. Shareholders are usually expecting a 2-for-1 stock split every 10 months, not a 65 percent drop in its value.

“The law of large numbers has taken effect,” Perica said. “But I think it’s going to take a little bit more of an economic slowdown to impact Cisco. They’re all over the world, so the impact shouldn’t be nearly as dramatic as it will be for others.”

Don’t tell that to CIBC World Markets analyst Steve Kamman who undressed Cisco a few weeks ago and cut the stock from a “buy” rating to a “hold,” essentially saying Cisco’s aggressive acquisition strategy wouldn’t be enough to keep it on the cutting edge of this rapidly changing technology.

“We believe Cisco will not make consensus revenue estimates in fiscal year 2002 and expect it will no longer be able to rely on appreciating stock as a currency," Kamman said in his report. He said 30 to 40 percent revenue growth is now mathematically unlikely, and expects a long-term revenue growth rate of 20 to 25 percent from now on.

Kamman said Cisco is likely to see a slowdown over the next six months.

Perica disagreed, saying the recent slump in Cisco shares reflects “an expectation of some type of shocking news this quarter that just isn’t going to happen.”

Last quarter, Cisco topped analysts’ estimates when it returned a profit of $1.36 billion, or 18 cents a share, on sales of $6.52 billion.

While the stock has steadily drifted lower for almost a year, 37 of the 40 analysts tracking it maintain either a “buy” or “strong buy” recommendation.