Cisco woes drag tech stocks lower

4 min read

Cisco Systems' disappointing second-quarter earnings and outlook took their toll on technology stocks Wednesday, pulling the Nasdaq composite down 57 points to 2,607.91.

The Dow Jones industrial average shed 11 points to finish at 10,946.72.

“Technology is definitely the black plague today. It looks horrible,” said Gary Kaltbaum, technical analyst at J.W. Genesis. “When you have high (stock price) valuations and decelerating earnings, it's usually a lethal combination.”

Competitors' and suppliers' shares lost ground as Wall Street assessed what Cisco's outlook would mean for the technology sector. Cisco (Nasdaq: CSCO), which makes Internet networking gear, is among the world's most valuable companies.

Cisco shares fell $4.69 to $31.06--well off their 52-week high of $82. Cisco shares are trading at their lowest levels in 18 months.

Cisco missed Wall Street estimates with earnings of 18 cents a share on sales of $6.75 billion. It also forecasts flat sales for the next two quarters. Cisco’s outlook and results present these problems:

  • The tech-heavy Nasdaq will be hurt by the downgraded Cisco shares because the charts for the two entities overlap. That's no surprise since Cisco accounts for 7.5 percent of the Nasdaq composite's market capitalization.

  • The slowdown in telecommunications-carrier spending dinged Cisco's quarter. That means Nortel (NYSE: NT), down $2.42 to $33.09 and Lucent (NYSE: LU), off 85 cents to $17.01, are going to struggle.

    Analysts said profit margins at Cisco and its rivals are likely to fall because of bloated inventory levels.

  • Cisco's rivals were down across the board.

    Upstart Juniper (Nasdaq: JNPR), which has been taking market share from Cisco in the Internet router arena, shed $7.81 to $94.38. Ciena (Nasdaq: CIEN) fell 63 cents to $82.06, Redback (Nasdaq: RBAK) closed off $1.13 to $41.56 and Sycamore (Nasdaq: SCMR) dipped $3.31 to $23.69.

    This isn't the first time networking equipment companies have suffered due to Cisco's woes. Juniper and Redback were downgraded last month after Cisco hinted it would have a "challenging quarter."

    Analysts said Cisco's quarter is troubling because it included January results. If January was tough for Cisco, it's logical that Ciena and Sycamore--two companies that also ended their quarters Jan. 31--will see problems.

  • Cisco's suppliers will take their lumps. Cisco said its inventory has doubled in six months. That means companies that provide components such as chips to Cisco will have trouble selling to the company.

    PMC-Sierra's (Nasdaq: PMCS) recent earnings report makes the point. The company said orders came to a screeching halt in the second half of the quarter when its largest customers, Lucent and Cisco, canceled or delayed orders. That caused analysts to downgrade PMC-Sierra, which lost $7.81 to $58.75, and also cut targets on Broadcom (Nasdaq: BRCM), down $9.81 to $82.69, and Applied Micro (Nasdaq: AMCC), off $5.25 to $49.81.

    Lehman Brothers analyst Daniel Niles said Cisco's inventory levels are outpacing revenue growth. Ditto for Nortel and Lucent.

    "We believe the semiconductor environment will get significantly more difficult once Cisco starts reducing inventory, but Cisco doesn't expect to be able to do this for two to three quarters," Niles said. While Nortel has made more progress at purging inventory than Cisco or Lucent, it will still need at least a quarter to move inventory.

    Broadcom, which derives about 12 percent of its revenue from Cisco, will get hit with a double whammy. The company will suffer as Cisco plans to reduce its inventory to normal levels in upcoming quarters, said WR Hambrecht analyst Jim Liang, who slashed his price target on the stock from $200 to $125 Wednesday. Cisco also mentioned that enterprise sales are slowing; Broadcom gets 30 percent of its revenue from the enterprise market.

  • Other "Internet infrastructure enablers" will struggle. If Cisco is seeing problems, analysts concluded that other highfliers may also have problems.

    Bear Stearns analyst Andrew Neff cut estimates on Sun Microsystems (Nasdaq: SUNW), off $1.25 to $26.56, and said its stock could face "tough sledding" as management may lower guidance at its mid-quarter update call later this month.

  • Contract equipment manufacturers will feel the strain. What has made the shares of Flextronics (NYSE: FLEX), Solectron (NYSE: SLR) and Jabil Circuit (NYSE: JBL) so popular on Wall Street? Strong growth fueled by outsourcing from the likes of Cisco, Nortel and now Lucent.

    "While our existing near-term forecasts for (these) companies show only modest, if any, sequential growth, we believe the current economic environment suggests further pruning is in order," said SG Cowen analyst David Foropoulos.

    Foropoulos maintained his estimates on Flextronics, off $2.94 to $23.94, and Solectron, down $3.95 to $32.45, but trimmed revenue targets for Jabil, which gets about 20 percent of its sales from Cisco. Foropoulos gave Jabil a "modest sales haircut, primarily to reflect exposure to Cisco."