Nortel falls on downgrades, analysts slash estimates

4 min read

Nortel plunged 36 percent Friday as analysts came down hard on the Canadian communications equipment company; most lowered their ratings and second-guessed even the company's drastically lowered expectations.

Nortel (NYSE: NT) shares opened down $10.65 to $19.10 after the company announced Thursday that it was lowering profit and sales expectations, and would have to slash 10,000 employees, up from previously announced numbers.

Analysts expected things to get ugly, but not this ugly.

Nortel's revised revenue forecast for the first quarter is 22 percent lower than what the company said it was expecting just three weeks ago. Nortel also said it sees a longer drought period, with the U.S. market slowdown continuing well into the fourth quarter of 2001.

The breadth of the company's problems was also worse than anticipated. Nortel said the biggest slowing is occurring in long haul optical and circuit switches, while the metro market and international markets are the only bright spots.

Nortel blamed the slowdown on several factors, including:

  • deferred spending by U.S. carrier customers until at least the fourth quarter;

  • carriers willing to run equipment at above-normal capacity instead of adding more hardware; and

  • delaying of next-generation wireless installations to 2002.

Nortel's warning marks a sudden turnaround. The company in January met fourth-quarter expectations and reaffirmed earnings expectations for the first quarter, while slightly trimming revenue projections.

The company announced a week ago that it planned to trim its work force and concentrate on high-growth markets.

"This sector has turned ugly fast. We had sensed...weakness in (the first quarter), but we did not expect Nortel to see this much weakness and lack of visibility," Merrill Lynch Analyst Tom Astle wrote in a research note.

Lehman Brothers analyst Tim Luke maintained his "buy" status and said Nortel's news indicates a "faster and more severe slowdown in U.S. telecom carrier markets than expected."

Luke downgraded Nortel in October, because of uncertainty about carriers' spending plans.

Analysts were also surprised to see weakness is not confined to a few customers.

"We would have thought NT's high exposure to companies like Worldcom (Nasdaq: WCOM), Williams (NYSE: WCG), and Level 3 (Nasdaq: LCLT), which have indicated lower-spending plans, might have explained some of the weakness," Astle said.

Analysts weren't content to bring their estimates in line with the company's this time. Astle lowered his rating from "buy" to "accumulate," and slashed his estimates well below the company's new targets.

For the first quarter, Astle cut revenue to $6.3 billion from $8.1 billion, and cut earnings to 4 cents a share from 15 cents a share. He also dropped his 2001 revenue number to $33 billion from $39 billion and earnings to 74 cents a share from 95 cents a share.

"Even with our lower estimates we would not attribute a high level of confidence to these numbers," Astle said.

Credit Suisse First Boston Analyst James Parmelee also cut his estimates significantly lower than Nortel's projections.

"Our more conservative estimates...reflects the difficulty in assessing the timing of an improvement (among) service provider(s)," the analyst said.

Parmelee downgraded Nortel to "buy" from a "strong buy" rating and halved his price target to $40 from $80.

The domino effect
Nortel's suppliers and competitors also headed south following the news.

Corning (NYSE: GLW), down $6.50 to $35.50, confirmed expectations for the first quarter, but ratcheted down growth targets for the full year and said it may announce layoffs. It issued the news directly in response to Nortel's announcement.

Among networking stocks, Cisco Systems (Nasdaq: CSCO) lost $2.06 to 28.75; Juniper (Nasdaq: JNPR) dropped over 9 percent, down $8.56 to $83.63; Sycamore Networks (Nasdaq: SCMR) fell $1.56 to $25.25. Optical network components maker JDS Uniphase (Nasdaq: JDSU) was downgraded at First Union and shed over 13 percent, off $6.13 to $39. Ciena (Nasdaq: CIEN), which raised estimates for 2001, lost $2.19 to $86.81.

Competitors didn't get any good news out of Nortel's weakening. Analysts said the company did not appear to be losing share to other players.

Analysts said the only competitor that could be squeezing some business out of Nortel is Ciena, which reported a strong quarter yesterday and raised guidance. The discrepancy seems to suggest that Nortel may be losing some market share in the long haul market in which they compete.

Though there may be some speculation that Ciena is taking share, "Ciena's total business is still a fraction the size of NT's optical business and thus not a major issue," Astle said.

Long-term view
Most analysts remain confident Nortel is well-positioned for the long term. The company is still the dominant optical systems vendor, the second-largest supplier of wireless infrastructure equipment and one of the leading providers of data networking systems.

ABN AMRO Inc Kenneth Leon, who downgraded the stock to "hold" from "buy," saw a "U-shaped outlook" for the stock.

"The market for these systems will return," Astle predicted. The analyst noted that bandwidth demand is still climbing, and carriers will, at some point, have to return to adding capacity to their networks. "When this occurs Nortel should see a return to 20 percent to 25 percent growth rates," he added.