Start-up blues in networking?

Summary:Former high-flying small companies in the communications industry face a less-certain future in the midst of an unrelenting downturn in their fortunes.

Former high-flying small companies in the communications industry, such as Sycamore Networks, Redback Networks and Foundry Networks, face a less-certain future in the midst of an unrelenting downturn in their fortunes.

The young network equipment makers, also represented by companies including Extreme Networks, Juniper Networks and Copper Mountain Networks, burst onto the networking scene with red-hot initial public offerings in 1999, finding instant success against networking behemoths like Cisco Systems and Nortel Networks. They are often referred to as the "Class of 1999."

The companies, armed with cutting-edge technology, saw their revenue and stock price soar as they fed telecommunications service providers’ big appetite for high-speed gear that accelerated private business networks and the public Internet. The boom was perhaps best represented by the 525 percent first-day jump in Foundry's stock--a once unheard-of one-day performance for a new offering.

But now these networking companies are faced with the biggest tests of their young lives as a growing list of customers--particularly emerging service providers--go out of business and the U.S. economic slowdown begins to seep into the international markets. Though Juniper has been unscathed thus far, Foundry, Extreme and Sycamore have all issued profit warnings in the past week, joining Redback and Copper Mountain, which previously issued warnings. Some analysts say the recent financial troubles will fuel more talk of potential mergers between the young companies, much like the recent rumor that Juniper was in talks to acquire Redback.

"It will be a challenging time for the next year to a year and a half, and consolidation is always a possibility," said Gartner analyst Tim Smith. "Any one of them could be a likely acquisition candidate if some of the larger companies want to solidify their positions with various products."

The news could also be dire for those that followed the golden road blazed by companies such as Juniper and Sycamore in 2000. Start-ups Corvis, Avici Systems and CoSine Communications, have seen their prospects plummet amid an imploding market that has spared no equipment maker.

Big coffers and lower costs
Some companies, such as Sycamore and Extreme, are cutting costs and laying off employees, exactly the conservative approach they have to take during the tough economic times, Wall Street analysts say. Despite the financial woes, analysts believe the young networking players can muddle through the economic downturn and stay independent because of their available cash.

"These franchises have staying power because of their technology," said analyst Chet White, of Wells Fargo Van Kaspar. "Juniper, Redback, Sycamore and Foundry all have decent balance sheets. They could burn through a couple hundred million dollars, but they have the staying power."

Some are in better financial shape than others. Despite seeing its third-quarter revenue fall by half, Sycamore has more than $1 billion in cash and investments. Redback has about $433 million, and Foundry has about $252 million. Others, such as Copper Mountain and Extreme, have about $160 million in cash.

"Every company has pristine balance sheets," said analyst B. Alexander Henderson, of Salomon Smith Barney. "Sycamore's got five years of cash flow. It will make it through the morass and could completely reinvent itself in two years."

The companies that are in financial danger--and ripe for acquisition--are the current crop of networking start-ups relying on venture capital funding, Henderson added.

More challenges ahead?
Smith said Redback and Copper Mountain could face the toughest challenges because they focus on broadband access equipment, such as digital subscriber line connections. Many emerging DSL carriers that bought equipment, such as NorthPoint Communications, Jato Communications, and PSINet, are either out of business or struggling.

Though Foundry and Extreme have been hurt by the death of some dot-com customers and sluggish sales to emerging carriers, the pair sells equipment aimed at the Internet. So in the long term, the companies are in good shape because carriers will need to continue to build out their networks and make them faster, Smith said.

The same goes for Sycamore, which sells optical-networking equipment for large telecommunications networks that feed the Net appetites of businesses and consumers, he added.

Juniper has so far stayed on strong financial footing for the same reasons. The company, whose main competition is Cisco in the high-speed core router market, is in good position because service providers need its products to build faster networks. The company also continues to steal market share from Cisco.

"Despite the spending concerns, service providers have to add capacity to ease the bottleneck, so the category is still growing," Henderson said of Juniper.

Juniper reports earnings for its latest quarter Thursday.

Even though service providers' spending is slowing, they will still buy new equipment, analysts said. As more emerging carriers go out of business, the remaining ones will pick up the slack and continue to spend because they need to continue to satiate the demand for network bandwidth and services, analysts say.

"Carriers will continue to spend if they are wise," Smith said. "They will be investing to improve their competitive position going forward and that suggests continuing to invest in new technologies."

Topics: Networking, Broadband, Cisco, Start-Ups

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