Cautious optimism pervades industry
For the first time in several quarters, the fourth quarter of 2002 was a remarkably uneventful reporting period. With the exception of Lucent Technologies, investors were greeted with in line to slightly better sales results and cautious first quarter 2003 guidance. Focusing on wireline carriers, there was very little news of note in terms of capital-expenditure cuts with the median U.S. service-provider decline prediction for this year, slicing 7-8% more from spending levels. Managing that should be a walk in the park in contrast to the near 50% cut that faced equipment suppliers in 2002.
Why talk about this now? We will soon be seeing the first quarter reports for 2003. Ciena's and Lucent's mid-February guidance updates may prove the early signposts of another uneventful quarter. "Stabilization" was the word used most often on company fourth-quarter conference calls, and this year's first quarter looks like it might prove that claim.
There were a couple of other tea leaves that were worth reading in last year's fourth quarter that could be part of a more favorable investment climate for the sector over the balance of this year. While fourth-quarter sales performance was unremarkable in contrast to expectations, we have begun to see most companies make substantial strides in cutting operating losses despite dismal sales results.
Nortel Networks was perhaps the most striking example where the consensus pro forma loss per share estimate was 6 cents, and the company bettered that by a nickel. At the operating income line, Nortel was at about breakeven, excluding unusual items compared to over a half-billion-dollar loss the previous year. That was despite sales being over $900 million lower than the year-earlier period, and it would seem to have Nortel within striking distance of its goal of being profitable in the second quarter. It is beginning to look like companies have gotten their costs more in line with the reduced-demand reality that faces the industry today.
The other observation we wanted to make is that investors and analysts have had a keener focus on top line growth than the bottom line for more than a year. But it appears we may be reaching the point where some of them are beginning to focus on rising profit potential against a backdrop of anemic sales growth.
Corning looks like an example where that transition may have occurred with great benefit to its shares. In early November, the consensus sales view for Corning was $3.3 billion and a loss per share of 11 cents. Following the company's February analyst meeting, sales estimates slid to $3 billion, but the loss prediction shrank to just 3 cents, with more than a handful of analysts actually expecting a full-year profit. During that time frame, Corning's shares rose from $2.80 to more than $5.
It might be argued that the fourth quarter was just such a trigger point for Nortel. Its losses peaked in June 2001 and fell dramatically for the next five quarters. However, the near halving of sales over the same period drove the direction of the stock, with it falling from more than $7 following the second-quarter 2001 report to less than 70 cents by the time the September 2002 results were released. But the December report, which produced only a modest sequential improvement, along with caution on the sales outlook for March, nonetheless triggered nine stock opinion upgrades. The stronger operating performance after six quarters was noticed.
Despite my new role in SoundView's banking organization, which doesn't provide as many opportunities to check the tone of the sector, I am continuing to see signs of improving health in the optical communications market. Certain managements are sounding more confident, even though they are quick to throw a little cold water on any positive comment. Of course, there are also plenty of companies that think they need to become diverse industry participants—in some instances, retracing paths they once plowed and determined lacked attractive growth prospects. It comes from two years of training at the hands of devastating industry conditions. But just as spring has arrived, there do appear to be companies where the spirits are rising and a call to action has occurred within those organizations.
We are seeing companies behave as though they believe the bottom has passed. If the prospects of their current core activities look diminished in the new world, they are beginning to look for ways to reorient and improve the future. If there is a future and no cash, they are looking to combine with others that are cash rich but have less interesting product prospects. At all levels, the cleanup is underway in earnest and that promises to make 2003 a better year for investments in the sector.
We have often discussed the need for restructuring of the carrier services business. Some would have the government be the impetus for change. Not recommended. Little by little, industry itself is making beneficial changes, without waiting for the government, and doing it better. In an example that occurred during the first quarter of this year, AT&T Wireless and Sprint announced a tower sharing deal. No, this isn't optical, and it doesn't translate to greater equipment sales. It is smart, however, and throughout the carrier business, we need the companies to be run smarter, because that will mean happier customers, better service, and better profits. We think the industry will continue to do things better, and by the way, the "next gen" hardware that everyone talks about is better and will be deployed as carriers regain their footing. ..
Kevin Slocum is managing director in investment banking at SoundView Technology Group (Greenwich, CT). He has more than 20 years of financial industry experience, including institutional equity research sales and analysis, and has been named to the Wall Street Journal's prestigious "Home Run Hitter" list two consecutive years. He can be reached at 203-321-7200 or email@example.com.
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