Brother, Can You Spare a Router?

One of the recent fantasies that has been bandied about was that the tech sector, in specific telecommunications and fiber optic companies, has bottomed and may be rebounding. There's no way that this is the case. We are not even close to being done with the bankruptcies of debt-laden carriers, and accounting scandals have not helped. But for those who can be patient, there might be rewards here.

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By Bill Mann (TMF Otter)
February 22, 2002

OK, for the first time in my, and maybe Motley Fool's history, I am going to publicly try my hand at technical analysis. We're going to use a three-year chart for Ciena (Nasdaq: CIEN).

See the "head & shoulders formation"? What was once at nearly 150 now sits at 8. And if it breaks that 8 level, it might even go to, well, 7.

I'm joking, sort of. I'm picking on Ciena simply because it happens to be old enough that it has a trading history from before the great telecommunications boom and bust of the late 1990s. Ciena stock dropped significantly yesterday when management disclosed that its second-quarter revenues would be as much as 30% lower than expected due to two big customers dramatically ratcheting back their spending. I'd put it at nearly 100% that the two companies were Qwest (NYSE: Q) and WorldCom (Nasdaq: WCOM), both of which have gone through liquidity crunches amid fears about their debt loads.

What I really found interesting about Ciena's announcement is that the stock only dropped about 8% upon release of the news before the market opened. Yeah, 8% still comes to more than $200 million evaporated based on a revenue shortfall of only $48 million, but the degree to which companies recently have been pummeled for much lesser transgressions tells me that the majority of the investment community with any interest in Ciena and its ilk had already assumed that things were getting worse. Ciena stock didn't even react when it announced over the holiday weekend that it would acquire ONI Systems (Nasdaq: ONIS), which has a nice complimentary technology to Ciena's, along with massive operating losses throughout its short history as a public company.

Things are not good in the telecommunications industry, and, as such, things are miserable in the telecommunications equipment industry. As a test I have been watching the amount of Cisco (Nasdaq: CSCO) equipment available on eBay (Nasdaq: EBAY). As of 1:00 p.m. yesterday, there were more than 4200 pieces of equipment, the majority of which (once you scroll past the two pages of auctions that close in the next hour) had no bids on them. Ouch, ouch ouch. Ciena, Tellabs (Nasdaq: TLAB), and Cisco are much better off than many companies to weather the storm, due to the near complete absence of debt on their balance sheets.

Oh but what a storm it is! Realistically speaking we have no idea when it is going to get better, and unfortunately the telecom equipment companies are captive to the struggles by the telecommunications carriers.

And yet, up until a spate of warnings in the past two weeks, many telecom equipment companies had enjoyed a steady rise over the last few weeks in anticipation of a market that was "bottoming out," according to many pundits and the companies themselves. However, the last month has been brutal, as companies like Juniper (Nasdaq: JNPR) have found themselves on the wrong side of an all out run, down 50% or more.

As I hope people know by now, I'm not a big fan of "happy talk." The concept that the world was going to keep running along swimmingly is one of the real reasons that the stock bubble got to be so out of control in 1999. And as I've argued in the past, in the tail end of that bubble, companies, particularly in the telecom sector, were making spending decision that have turned out to be extremely damaging, if not fatal, as the recent spate of bankruptcies and restructures should have made crystal clear.

That said, let me be clear about my impression of the telecommunications market, and in particular, the equipment market. Things are not getting better. In fact, they're likely to get a heck of a lot worse in the near future. And the telecom companies that are burning cash or have debt overhangs -- i.e. Lucent (NYSE:) and Nortel (NYSE: NT) -- are likely to find themselves in a heap of trouble if the market remains weak.

The issue is this: carriers are collapsing. Period. The accounting scandals and Enronitis that is striking such companies as WorldCom, Qwest, and others in the wake of Global Crossing's abominations and fraudulent booking of fiber swaps has not helped. I am not a big fan of having stock prices dictate the level of capital spending of a company, because that smacks of revenue grooming. At the same time, in no way do companies that are in the midst of potentially needing to restate past earnings in an industry that looks nothing if not moribund want to continue capital expenditures apace. It's just not realistic to expect otherwise.

Is this industry dead? No, not at all. In fact, I expect that for those of us who are willing to be patient that we're going to look back at the price of Ciena right now and want to slap ourselves silly. There are certain areas where the telecom sector has some promise. Wireless usage continues to expand, even as it is maturing in many markets. In the wake of the terrorist attacks on the United States, companies are looking to dramatically increase the redundancy of all of their information services and virtual networks, which could go some way to eating up some of the bandwidth currently on the market.

These things are far, far below what the promise of the information revolution was going to provide carriers, ISPs, and the companies that provided the equipment that made these networks hum. The promise may well be fulfilled. Once enough carriers exit the market via bankruptcy, the economics are much more likely to revive for the survivors. But the buildout of the 1990s was nearly unprecedented in scope, and we may have a long way to go before equilibrium is reached. For those who have patience and a stomach of iron, the rewards of buying when others are fleeing may be substantial. For the shareholders of many companies, though, the money lost to date will be followed only by more losses.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Daniel Pearl: We won't forget. Bill Mann owns shares in Qwest and Cisco. The Motley Fool has a disclosure policy.