Nortel another "100-year flood" victim?

Summary:Though the company matched revised earnings estimates, Wall Street analysts think more trouble is yet to come.

Though Nortel Networks matched revised earnings estimates Thursday, Wall Street analysts think more trouble is yet to come.

Executives of the giant telecommunications equipment maker say the economic outlook is too murky to make predictions of future financial results, but hinted that the company's telecommunications customers may need to go on a spending spree soon.

In a conference call with analysts Thursday, Nortel executives reiterated concerns over the dismal economy that were expressed earlier this week by Cisco Systems, which issued a profit warning and a bleak forecast for the next quarter. Cisco Chief Executive John Chambers compared the telecommunications downturn to a " 100-year flood" that no one anticipated.

"It's hard to predict how the overall business will turn out for the year," said Nortel Chief Executive John Roth, whose customers include telecommunications service providers and other businesses. "A lot of what's going on is driven by the shortage of capital. (Customers) want to desperately buy the equipment, but they can't raise the money to do so."

Nortel Chief Financial Officer Frank Dunn said carriers' networks are at 70 percent to 85 percent capacity. Even if Internet traffic grows at half the pace of last year, carriers should reach capacity in four months. Although carriers will lease extra network capacity from other carriers, Dunn suggested that the carriers have to buy more optical networking equipment soon.

"They will be compelled to add capacity," he said.

But Wall Street analysts say Nortel is being too optimistic.

"We think carriers are pushing the utilization rates up beyond what they would have used in years past," Salomon Smith Barney analyst B. Alexander Henderson said in a report. "We think there is a one-time divot in demand...We think it's more like six to nine months as compared to management's indication of 3 to 4 months."

Morgan Stanley analyst Alkesh Shah said in a research note that spending for optical equipment could increase in the next six to 12 months.

Nortel on Thursday announced a first-quarter loss of $385 million, or 12 cents per share, on revenue of $6.18 billion. Revenue was down 2 percent year over year and 30 percent from the previous quarter. Like Cisco, Nortel executives said North American sales dropped sharply. But while its rival faced slower international sales, Nortel said its sales in Asia and Europe remained fairly healthy.

"We're getting good growth in the European markets. The visibility looks good, but we felt that way about North America late last fall, too. (So) we're approaching it with caution. We continue to watch if it follows the U.S. pattern," Roth said. "Asia is very strong for us and we're far less concerned about the Asian markets."

Sales of Nortel's optical equipment used by carriers to send Internet data over long distances fell to $1 billion, a 30 percent drop from last year and 53 percent drop sequentially. But wireless products grew to $1.4 billion, a 38 percent increase from last year. Optical networking equipment for metropolitan networks also saw growth.

Nortel executives said the company expects to slash 20,000 jobs by summer, an additional 5,000 people from its earlier announced layoffs. The layoffs are expected to result in $2 billion in savings a year.

Nortel added that its loans to service providers increased to about $1.8 billion, up $260 million from the end of 2000. Its total-commitments number, however, has fallen to $4.7 billion, down $1 billion from the end of 2000, executives said. Total commitments is the total amount Nortel has promised to loan to carriers if they comply with all facets of the loan agreement, such as making profit numbers.

Analysts have been concerned about loans to service providers because many start-ups have defaulted. Nortel executives, however, said 90 percent of their loans are to incumbent and profitable carriers.

Overall, analysts believe Nortel's customer spending won't improve until 2002, possibly as late as 2003.

"We doubt the service providers can get healthy until the capacity in the network becomes tight. This implies that the network needs to tighten before they can start to fix the business model and then they can start to spend again," Salomon's Henderson said. "We think this will take all year to develop at the earliest, and we suspect it is more of a 2002 event."

Analyst Paul Sagawa of Sanford C. Bernstein expects that second-quarter sales will be down 18 percent from last year's second quarter. Sagawa predicts a loss of 7 cents per share and says demand for products won't improve until 2003.

"We do not project any meaningful improvement in industry demand until 2003," he said in a report.

Topics: Cisco, Fiber, Networking

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