Report: Industry downturn to extend deep into 2002

The current slowdown in the telecom equipment industry is likely to last another year, according to a recent report by a Wall Street investment firm.

UBS Warburg LLC says the softness in the enterprise and service provider equipment markets may extend through the end of 2002 due to sharp reductions in capital expenditures, a consolidation in the service provider market and the slow rollout of next-generation products, such as 3G wireless gear. The current malaise was expected to last only this year with an uptick anticipated for 2002.

As a result, revenue growth in the industry this year will be the lowest it has been in 8 years, UBS Warburg states in its report. The 15 percent to 25 percent growth the industry has enjoyed in the years prior to the recent downturn will not be seen again until 2003, the firm states.

"We now believe telecom equipment revenue growth in 2001 will be below 10 percent," the firm states in a report distributed earlier this week. "This will be the first year since 1993 that growth will not be in the 15 percent to 25 percent range."

UBS Warburg had said as recently as January that it expected the industry to grow 10 percent to 15 percent this year. But recent visibility into three of its major holdings - Nortel Networks Corp., Cisco Systems Inc. and Juniper Networks Inc.- prompted the firm to lower its forecast to 9 percent for 2001.

The company has also reduced its estimates for Cisco and Nortel, and cut its stock price target for Juniper by 60 percent.

"We expect continued reductions in growth forecasts by telecom equipment companies between now and when they report first quarter results in April," the firm states in its report.

The firm cites several reasons in its report. First, WorldCom Inc., a major customer of all three vendors, has "dramatically" cut back spending across all products lines as it "tries to rationalize its business," the report states.

Another is that Ciena Corp. is taking market share from Nortel in long haul optical systems, particularly at Qwest Communications International Inc., which is one of Nortel's largest customers. And Lucent Technologies Inc. is pricing its OC-192 optical systems "aggressively" in order to win business among greenfield carriers, a move that could force Nortel to do the same and erode margins.

Also, Nortel optical customers Williams and 360 Networks have received extended payment terms from Nortel to encourage additional deployments, and 360 has cut spending by US$200 million to $300 million. And 3G wireless deployments have been "pushed out" across the entire industry - Nortel's win rate on new contracts has decreased in the last two months, the firm states.

With regard to Cisco, UBS Warburg believes the company will show negative sequential growth of 6 percent for its April quarter instead of the flat-to-negative 5 percent Cisco gave as guidance last month.

"Special promotions (e.g. deferred payment plans for emerging carriers) and some slowing in the distribution channel suggests that the first month of this April quarter was soft," the firm states.

UBS Warburg also believes Cisco will fall "way short" of its $3 billion to $7 billion goal in optical revenue for 2001.

Cisco's exposure to service provider "rationalization," however, will be buffeted by its consumer and small/medium/large enterprise businesses, which account for 70 percent of the company's revenue, UBS Warburg states. Also, Cisco is more likely to benefit from lowered interest rates which could boost IT spending among enterprise customers, the firm notes.

Juniper, meanwhile, will not realize any material revenue from 3G wireless buildouts in 2002, UBS Warburg predicts. Juniper allied with Ericsson recently to develop mobile IP gateways using Juniper routers for 3G wireless networks.

Also, the "rationalization" taking place at WorldCom, which accounts for about 20 percent of Juniper's sales, could impact the router company.

"We believe if there is a material sequential decline in sales to WorldCom in the first quarter, it will be difficult for Juniper to show any upside this quarter," the firm states in its report.

Juniper also has exposure to Tier 2 carriers who are being more conservative in capital spending that Tier 1 carriers. And some of Juniper's customers are reducing visibility regarding orders and forecasts.

Nonetheless, UBS Warburg continues to believe that Juniper can capture 40 percent of the Internet core router market and 10 percent of the edge router market in 2002. For the telecom equipment industry overall, though, there's the "likely scenario of slow industry growth for the next two years," the UBS Warburg report states.