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Networking shares sink on Nortel warning

Shares of the communications equipment company plunge 36 percent as analysts come down hard on it, cutting their ratings and second-guessing lowered earnings forecasts.

    Nortel shares plunged Friday as analysts lowered their ratings and second-guessed even the company's drastically lowered expectations.
    Nortel
    Stock price from February 2000 to present.  
    Source: Prophet Finance

    Nortel shares closed down $9.75, or nearly 33 percent, to $20 after the company announced Thursday that it was lowering profit and sales expectations and would cut 10,000 employees.

    Investor pessimism spilled over to networking companies, dragging down the shares of Cisco Systems, Juniper Networks and Sycamore Networks. Just prior to the close of regular trading, the Nasdaq was off more than 100 points to about 2,440.

    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. The company also said it expects the tough times to continue, with the U.S. market remaining stagnant well into the fourth quarter of 2001.

    Specifically, Nortel noted a slowing in the market for long-haul optical and circuit switches. However, the metro and international markets remain bright spots, the company said.

    Nortel blamed the slowdown on several factors, including:

    • Deferred spending by U.S. carriers until at least the fourth quarter.

    • Carriers willing to run equipment at above-normal capacity instead of adding more hardware.

    • Delay of next-generation wireless installations to 2002.

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

    But last week Nortel announced 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 Friday.

    Lehman Brothers analyst Tim Luke maintained his "buy" 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 also surprised to see weakness is not confined to a few customers.

    "We would have thought (Nortel's) high exposure to companies like WorldCom, Williams, and Level 3, which have indicated lower spending plans, might have explained some of the weakness," Astle said.

    Second-guessing
    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...reflect 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 after the news.

    Corning, 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 lost $2.06 to $28.75; Juniper Networks dropped $8.56, or more than 9 percent, to $83.63; Sycamore Networks fell $1.56 to $25.25. Optical network components maker JDS Uniphase was downgraded at First Union and shed $6.13, or more than 13 percent, to $39. Ciena, which raised estimates for 2001, lost $2.19 to $86.81.

    In addition, analysts said the only competitor that could benefit from Nortel's woes is Ciena, which reported a strong quarter Thursday and raised expectations for future quarters. The discrepancy seems to suggest that Nortel may be losing some market share in the long-haul market in which the companies compete, analysts said.

    Though there may be some speculation that Ciena is taking share, "Ciena's total business is still a fraction the size of (Nortel'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 analyst 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."