Taking Stock: Searching For Bottom In Telecom Market

Hold investments until we get a sense of when the market will bottom out.
The collapse of the telecom equipment market has been nothing short of spectacular. Quarter after quarter of revenue declines and announcements of layoffs have become the norm. However, at some point the bleeding will stop and revenue will slowly inch upward as carriers start spending again. Following the latest slew of earnings announcements, it's worthwhile to check in on some of the telecom equipment providers.

Lucent Technologies has reached a higher state of perpetual restructuring partly because of its own missteps and partly because of the decline in the telecom equipment market. Lucent recently announced another round of layoffs, this time eliminating 10,000 jobs with the goal of bringing the total workforce down to 35,000 -- less than a third of the staff size at its peak. Lucent's revenue during the third quarter declined 23% from the prior quarter, with much of the weakness originating in North America. Sales of wireless equipment were particularly weak. Expectations of a 10% quarter-over-quarter revenue decline for the next quarter is a clear indication that Lucent's business has yet to stabilize.

Nortel Networks' quarterly results were better than Lucent's, but that's about the end of the good news. Revenue fell 15% from the previous quarter, and the sales decline is expected to continue. The weakness in Nortel's business is across the board -- wireless, wireline, and optical. Management predicts that capital expenditures by telecom carriers will decrease again next year. That would be the fourth year of declining capital expenditures from the carriers, which would make this cycle much longer than first anticipated. Lucent and Nortel now have about the same revenue, about $2.3 billion in their most recent quarter. However, this also means that the two combined are now smaller in terms of revenue than the 800-pound gorilla, Cisco Systems.

Many smaller companies in this market have suffered even more than the bigger ones. These companies often brought innovative technologies to the table, and the telcos had been willing to experiment. That's no longer the case. Sycamore Networks, for instance, has seen its quarterly revenue decline from $149.2 million at its peak to $8.5 million. Juniper's revenue is down 75% from its peak quarter, while Ciena's revenue is off almost 90%. This is an industry that clearly needs to consolidate, yet there's been very little consolidation so far .

Cisco, the biggest and most profitable networking company, reported that revenue was flat quarter over quarter, actually quite a feat given the poor showing of its competitors. However, Cisco expects that revenue will be flat to 4% lower in the next quarter. Cisco's service-provider segment continues to suffer from revenue decline and no ability to forecast the next quarter. Of note was the growth in Cisco's gross margin, evidence of good cost controls and a willingness to squeeze suppliers. Suppliers of components to the telecom equipment industry have seen any pricing power they once had evaporate because of excess supply.

There's little evidence that the telecom equipment industry has seen the bottom of this downturn. We are undoubtedly moving closer to a bottom, but when we will hit it remains highly uncertain. Indications now are that it might not be reached until some time next year. Until we get a sense of that, any investment is probably better saved for some other sector.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected].

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