Promise Less, Deliver More

We've seen three Rule Maker companies blow up this year after executives forecasted strong growth right in the teeth of a slowing economy: JDS Uniphase (Nasdaq: JDSU), Cisco (Nasdaq: CSCO), and now Nokia (NYSE: NOK).

In October, after telecommunications systems provider Nortel (NYSE: NT) reported weaker-than-expected revenue growth, former Rule Maker JDS reported strong fiscal first-quarter revenues. On the quarterly conference call, management assured investors it saw no signs of weakness in demand.

Chief Executive Jozef Straus said, "Recent concerns regarding spending at the carrier level do not affect growth in optical networking equipment because fiber optics provides overriding benefits in terms of declining traffic costs." Then Straus raised fiscal year revenue growth estimates to the 115% to 120% range from the 80% to 90% range.

That kind of growth isn't going to happen. The telecom equipment market fell off a cliff earlier this year, sparing no one. Last week JDS again reduced fourth-quarter sales forecasts, this time to $600 million from $700 million, and warned that Q1 revenue will come in around $450 million, compared to $786 million a year ago. Over the last 12 months, shares of JDS dropped 90%.

Cisco Chief Executive John Chambers spent a good deal of time last fall and early this year spreading expectations that the company's sales would continue to grow 30% to 50% annually for the next five years. In February, he was quoted in Fortune magazine saying, "I think it's not just possible, but probable." At one point, Chambers and other Cisco executives maintained -- much like Straus -- that their company was insulated from an economic slowdown because of the cost savings available to companies with electronic business capabilities.

Back in February, analysts expected 55% sales growth in 2001, which would have given the company sales around $30 billion. It's not going to happen. Now Cisco expects sales in the neighborhood of $23 billion -- perhaps lower -- representing about 20% growth, or less than half what analysts expected and far below Chambers' own estimate. Cisco shares are down about 56% since Feb. 1.

Cellphone and telecom equipment maker Nokia managed to buck the slowing phone sales trend in 2000 and much of 2001. But last week the company lowered second-quarter sales growth to less than 10% from 20%, and announced plans to revise its sales forecast for the second half of 2001. This is a sharp turnaround for a company that projected 25% to 35% annual revenue growth earlier this year, even as the economy slowed and rivals struggled. Nokia shares are down 50% this year.

Now, the stocks of these high-profile growth companies would have taken a hit regardless of whether their chief executives were out telling the world about unstoppable growth prospects, but there are two issues worth addressing.

First, the next time an executive or analyst claims a company is immune from an economic slowdown, or insulated from industrywide trends, be skeptical. It's very difficult to predict the depth and breadth of a slowdown, but in the case of companies like Nokia and Cisco -- large companies that require near-perfect conditions to achieve expectations -- it's a bad bet to assume the company is protected.

Consider this: For Cisco to increase sales 55% in 2001, it would have had to grow revenues $10.4 billion in a single year. That's a steep climb in the best weather, and insurmountable in a telecom downpour. We could see Cisco's revenue base wobbling late last year as telecom carriers and Internet start-ups headed for bankruptcy court. The Rule Maker Port should have pared its holdings.

Second, there's a lot to be said for circumspect management. Think of how Microsoft (Nasdaq: MSFT) actively put a conservative spin on its prospects quarter after quarter, even in its go-go years. It wasn't virtue, and you could argue the company was merely angling to surprise investors with better-than-expected results, but I like that Microsoft erred on the side of caution and conservatism.

Chambers, Straus, and Nokia CEO Ollila came out in tough markets, and, rather than sitting back and letting the markets take a little wind out of the stocks, pounded the table about growth opportunities. It's a mistake to give into analysts' and investors' demands for non-stop growth projections, especially when the economy is clearly suffering. At the very least, the timing was bad. Who told Chambers to do that February interview?

I don't believe these managers were looking to mislead investors. They reported what they saw at the time. They had been growing so fast for so long, they were snow-blind. I'm not surprised they missed the signs. But as a manager of this portfolio, I see the projections as a strike against management quality. Executives often don't know what kind of growth rates to expect, and should say less rather than promise more than they can deliver.

Unfortunately, trotting out these kinds of estimates is the rule rather than the exception. Amgen (Nasdaq: AMGN), Pfizer (NYSE: PFE), eBay (Nasdaq: EBAY), and many, many others have set the growth bar high and may have trouble clearing it. 

Have a great day.