It's All Doom and Gloom for Networking Stocks

Earnings season is in full swing, and in spite of the pessimism swirling around the markets this week as the U.S. borders on default, corporate earnings are at all-time highs. In fact, with half of the S&P 500 having reported through this Wednesday, S&P earnings are on track to hit $24.93. That's an impressive 16% above last year's total. Perhaps most tellingly, that earnings figure would be an all-time record; finally passing record earnings seen in mid-2007 at a time when phony profits from the financial sector were fueling growth.

However, while the broader corporate landscape might be basking in record profits, so far this earnings season it has been mostly doom and gloom in the networking sector. Today we'll look at this earnings season's winners and the cavalcade of losers in the sector.

The winners' circle
I'm going to take an unusual step and proclaim a company that hasn't reported earnings and another whose earnings were pretty dismal as the winners of this earnings season. Cisco (Nasdaq: CSCO  ) and Tellabs (Nasdaq: TLAB  ) , come on down to the winners' circle!

The fact that I need to hold up two companies that are flailing as winners of this industry is sad enough, but the fact that they've both seen their share prices rise thanks to far-reaching layoffs says all you need to know about the current state of networking.

In Cisco's case, weakness at competitors has helped validate the company's view that the networking industry at large is seeing headwinds. Last week, Cisco decided to slim its work force by 6,500 employees. There is little doubt that a company of Cisco's size could use some trimming, especially after some misadventures into consumer-focused areas. However, while pruning of its employee ranks could help, the broader issue is that Cisco needs to refocus on securing its key networking models. The company clearly got greedy with its 12%-17% growth model and stretched itself too thin. In the coming years, its focus should be on preventing threats to its core routing and switching markets, while also taking share back in growth areas like load balancing and WAN optimization.

Tellabs has been hurting since it lost a major contract at AT&T (NYSE: T  ) , which surprisingly picked Alcatel-Lucent (NYSE: ALU  ) as a domain supplier. After this shell-shocking loss of a major customer, Tellabs floundered and its earnings dropped off a cliff. This week, the company reported a loss of $0.04 a share, below analyst estimates and well below last year's profit of $0.16 per share. Still, for Tellabs the damage has been done. Moving forward, investors are banking on seeing the company slim down operations and bag new customers.

I see the cost-cutting programs at both Cisco and Telllabs as short-term solutions that don't address the core concerns affecting their business. However, weakness at competitors does show that these companies' woes may have been more about general networking weakness than previously thought.

To stay updated:

The losers' circle

Company

Earnings Estimate

Actual Earnings

Return Through Earnings Season

Riverbed (Nasdaq: RVBD  ) $0.21 $0.21 (27%)
F5 Networks (Nasdaq: FFIV  ) $0.91 $0.97 (16%)
Juniper (NYSE: JNPR  ) $0.33 $0.31 (24%)

Sources: Thomson and Google Finance. Data through July 28.

Now we get to the more prominent losers' section. It's not necessarily that misses were that bad; Juniper missed earnings by a few pennies, Riverbed matched earnings, and F5 Networks handily exceeded expectations.

The point is that investors in this sector grew tired of slow-moving industry leaders like Cisco and bid up growth players like F5 and Riverbed to extremely high multiples. Under these conditions, matching expectations didn't require merely slightly exceeding earnings, it required smashing them. Unfortunately, no networking companies were capable of high-level performance this quarter.

In the end, Juniper's weakness probably reflects that expectations around data growth have grown inflated. As longer-term investments, F5 and Riverbed continue mopping the floor with Cisco. The willingness of network operators to work with best-of-breed operators in unique networking niches instead of larger one-stop-shops like Cisco is a great omen for these companies, but they also can't rest on their laurels. Given the time and its resources, Cisco's immense networking could refocus attention on these networking areas and make deep inroads.

For more:

That's it for our roundup of this earnings season in the networking sector. If you'd like to stay updated on all things networking-related, follow me on Twitter, where I'm on the lookout for great technology buys as part of my Rising Stars Portfolio. Or make sure to add any of the companies mentioned here to our free My Watchlist service, which provides up-to-date news and analysis on all your favorite companies:

Eric Bleeker owns shares of Cisco. You can follow him on Twitter to see all of his technology and market commentary. The Fool owns shares of and has created a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of Riverbed Technology, Cisco, and AT&T and shorting Juniper Networks. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 01, 2011, at 11:24 PM, BradReeseCom wrote:

    Hi Eric,

    It's my personal opinion that Cisco maybe artificially inflating switch gross margins by using huge trade in discounts that are then later billed as a sales and marketing expense (after all Cisco's sales and marketing expense during the most recent 9 months has increased a staggering +$878 million up +31% on a mere +$2.8 billion total net sales increase up +9.6%, over last year).

    For example, Cisco discounted the Nexus 7000 switch -76% to win Purdue University's Hansen Cluster bid on June 2, 2011.

    On page 4 of its winning bid, Cisco listed the quantity of each Nexus 7000 Switch Part Number sold to Purdue University and according to Cisco's own Nexus 7000 switch price list (page 31 dated July 11, 2011) the total USD list price of Cisco's Nexus 7000 switch sale to Purdue:

    $1,094,793

    The total amount of Cisco's Nexus 7000 switch bid that won Purdue University's June 2, 2011 RFP which includes the primary compute system network, warranty and licensing, shipping and installation:

    $254,600

    That works out to a -76.7% price discount (i.e. -$840,193)

    In my personal opinion, this is a major game changer because Cisco's customers now have a powerful new tool for negotiating with Cisco on upcoming Nexus 7000 switch deals.

    Sincerely,

    Brad Reese

  • Report this Comment On August 02, 2011, at 1:15 PM, TMFRhino wrote:

    Wow... Interesting feedback Brad Reese. I've been following the story line of Cisco having to discount more aggressively recently, but haven't seen anything on them artificially propping up GM's through means like that. I'll have to look into this more.

    Thanks for commenting!

    -Eric

  • Report this Comment On August 02, 2011, at 1:27 PM, Borisbmx wrote:

    Hi Eric,

    From what i gathered Riverbed had 68% product growth in the US and record gross margins. The european pipeline of deals was full but didn't close soon enough. Riverbed might be in winners' circle.

  • Report this Comment On August 02, 2011, at 2:41 PM, TMFRhino wrote:

    Hey Boris,

    I have little doubt RVBD is doing great, but was trying to highlight companies that were sold off.

    Of course, that sell off could be overdone as you allude to. Here's a good article from fellow Fool Tim Beyers that defends the company's quarter:

    http://www.fool.com/investing/high-growth/2011/07/29/why-are...

    Best,

    Eric

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