Nothing Super About SuperComm

By: Chad Hudson | Thu, Jun 13, 2002
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SuperComm, the telecommunications industry's big annual conference, was last week. It didn't have the pizzazz as in the past and this year attendance was down 30% from last year, and there were 28% fewer exhibitors. Amazingly, Wall Street analysts were unable to put much of a bullish spin on SuperComm and actually called it like they saw it. One analyst titled his research piece summarizing the conference as "Mediocrecomm."

A few items from a couple of the Wall Street firms: Bear Sterns said vendors continue to experience weakness in orders and visibility remains low. Expect spending to be down in the second quarter. "When the question about the second half of the year was posed, hands were thrown up in the air and most vendors replied that an up-tick was unlikely." Bear Sterns also noted that overcapacity exists, not only in equipment installed, but also in the number of vendors. This excess competition will constrain profitability when a recovery eventually develops. Bear Sterns thinks we are only one-third of the way through the capx correction. This second stage, of three, involves carriers reducing the percent of revenue spent on capx to the 10% - 12% range (currently around 15.5% down from a peak in 4q00 of 36%). Revenues are also expected to decline and balance sheet and funding problems will get addressed. This will most likely result in carriers going out of business. This will push the industry to consolidation and bankruptcies. As RBOCs move into the long distance business competition will only get worse. Bear Sterns did give a sigh of relief that "cuts are moderating in terms of overall size. Some vendors indicated that some service providers, …, virtually halted their wireline spending this quarter." I would hope future spending cuts would moderate if spending went to zero.

Credit Lyonnais Securities included a few anecdotal stories about the state of the industry. A couple of sales people indicated that the weakness could last for three years. This came from salespersons from PMC-Sierra and Transwitch. Representatives from Lucent and Nortel indicated that wireless spending should top out this year and then decline through 2004. Several wireless carriers are finishing major upgrades this year and there is little catalyst for any major upgrades for the foreseeable future. Another company posed the question that if the broadband companies were booking transactions that were artificially inflating revenue, how much overcapacity is there?

Intel's CFO, Craig Barrett, spoke at SuperComm last week. He reiterated Intel's cautious outlook, "Until you see some degree of corporate profitability in the US, Western Europe, and Japan, I think you're going to see limited IT investment…We will be a lagging indicator to the economic recovery in the US. It will be a form of trickle-down economics." This should not sit well with the economists calling for a recovery based on the resumption of capital spending. In fact, having the primary premise shot down by the CEO of one of the largest hardware companies should be frightening.

Intel also made news with its mid-quarter update last week. Intel announced that revenue would be lower than previously forecasted along with lower gross margins. Intel blamed lower microprocessors sales to the consumer segment along with slower European sales. Intel mentioned that the early June up-tick in orders that kicks off the back-to-school season has been softer than expected. Needham published an update after Intel's meeting that included a table with historical valuation ratios. Currently, Intel's stock trades at 41.5 times trailing operating earnings. Since 1990, Intel's average PE ratio has been 22.8, with a range of 9.9 to 65.4. This was during a period of unprecedented technology spending. Are Intel's prospects for growth really twice what they have been on average during the past dozen years? Admittedly, this is very superficial analysis, but it easily shows how lofty valuations remain. Intel closed today (Wednesday) at 21.58. The last time Intel traded in the 20s was in 1997-1998. At this time Intel was earning around $1.00 ($1.06 in 1997, $0.93 in 1998). Intel is expected to earn around $0.60 this year with expectations looking for $0.90 next year. Tuesday, at the Bear Stearns technology conference Intel noted that the first half of the year is progressing exactly as expected with no economic recovery and sales seasonally down.

Tuesday, Nokia announced second quarter revenue would decline sequentially by 2% to 6%. Previously, the company expected sales to increase 2% to 7%. The weakness is primarily due to its infrastructure sales and pointed specifically to China and Europe. Nokia anticipates that average phone prices should rise. This assumes consumers will trade up to newer phone with more features. However, some analysts are starting to figure out that these are phones and consumers are not necessarily interested in the newer features. In talking with an engineer with one of the chip companies, some of the features that will be on the newer phones include stereo headphone jacks and a digital camera. The reasoning for the stereo headset is so consumers can use it as a MP3 player. While neat, I'm not sure consumers will flock to stores to upgrade phones. Heck, most people cannot seem to drive and talk at the same time, now they are going to be taking pictures? Merrill Lynch noted that based on the numbers released; there has been a shift in product mix toward lower end phones. Merrill figures this could mean one of two situations. Are customers choosing lower priced phones or is Nokia losing the higher end segment to Ericsson and Samsung, which have already introduced high-end phones. If consumers are shifting to lower end phones, the idea that consumers will upgrade to 3G will be difficult to maintain.

SunTrust Robinson Humphrey (SunTrust) threw in the towel. In a research report published Wednesday, SunTrust lowered estimates on the software sector based on a survey conducted at a recent SAP user conference (SAP is the largest enterprise software company). While informal, the survey revealed that while the environment is not getting any worse, the recovery is non-existent. Only 26% of the respondents anticipate business to get better in the next 60 days, compared to 77% just a month and a half ago. SunTrust noted that the anecdotal conversations were even more bearish than the survey results. SunTrust expects forecasts to be lowered for the rest of the year as not only does it appear business will not rebound, but companies will resort to discounting to gain business. They also suggest more layoffs are inevitable as companies will "fight to attain or maintain profitability levels." A fourth quarter "flush" in spending would be predicated on an economic upturn, and would most likely simply pull forward first quarter 2003 sales. This leads SunTrust to forecast that the second quarter of 2003 might mark the beginning of the recovery. One last item the report focuses on is how forecasts are derived. Companies use what is in the current pipeline and an historical closure rate to forecast future results. During the bubble years, companies generally beat expectations because they were closing more deals than the historical norm. Now companies are closing fewer than the historical norm. SunTrust also points out that the pipeline could be meaningless since nothing flows out of it. Their conclusion: "how can we say a company should be trading at a multiple of revenue or earnings if those numbers are in question? Similar to how these stocks traded at astronomically high valuations in the good times, they can trade at abysmally low valuations in bad ones."


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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