Three months ago, Cisco Systems Chief Executive John Chambers sparked a sell-off in technology stocks when he highlighted soft spending by U.S. companies. The comments left investors asking whether the decline would persist. On Feb. 6, they got their answer.
During a conference call with analysts, Chambers said Cisco's revenue would rise a mere 10 percent in the quarter that ends in April. That's short of the 15 percent growth Wall Street had expected. Investors, who hang on Chambers' every pronouncement as a gauge of computer industry health, took the remarks as a sign that U.S. companies are cutting back on tech spending. Yet they weren't assuaged by his assurances that the slump would be short-lived. In extended trading, Cisco stock tumbled, dragging down shares of other marquee tech-sector names.
The bearish forecast, which equates to a US$450 million shortfall, overshadowed a fiscal second-quarter report showing a 7.2 percent increase in profit and 16.5 percent gain in sales, in line with analysts' estimates. It left investors with a bleak picture of U.S. corporate spending on a broad range of computer products. "We are at the front end of an economic slowdown [and Cisco] is the lead car in the whole chain," says Samuel Wilson, a senior analyst at JMP Securities. "It's another confirmation of a continuing stream of data points we've gotten in the past two months that business is decelerating."
Sharp decline in January sales
Sales of communications equipment are off, retailers and automakers have dialed back spending, and there's a better-than-even chance Cisco's core telecom and cable-TV customers will slow their spending by mid-year, Wilson says. In light of the new forecast, owning Cisco shares won't let investors outperform the Nasdaq composite index, he adds. "My outlook for the stock is pessimistic."
Cisco shares fell US$1.95, or 8.5 percent in after-hours trading, after shedding 18 cents to close at US$23.08 during regular trading on Feb. 6. Investors sold shares of Microsoft, Hewlett-Packard, IBM, Intel, and Apple in unison. Cisco's stock is trading near its 52-week low of US$23, and the shares could head lower in coming weeks, analysts say.
Sales fell off sharply in January compared with December, Chambers said during the conference call. January orders for the company's gear, used to knit together corporate data networks and beef up Internet capacity by telecom providers and cable TV operators, rose just 10 percent compared with a year ago, missing Cisco's internal forecasts by 4 to 5 percentage points. It was the first time in five years Cisco didn't make its January numbers, Chambers said. The company expects comparable order growth for several months, he said.
"A Confidence issue with CEOs"
Weak spending by retailers as well as automakers and other transportation companies hurt worst. Still, the financial-services companies that were the primary culprit of first-quarter softness increased spending 21 percent during the second quarter, which ended Jan. 26. "We cut the data every way imaginable," said Chambers. "What you're almost seeing is a confidence issue with CEOs."
Cisco, the largest provider of networking equipment, is viewed as a bellwether for technology spending. Chambers held fast to a long-term forecast that Cisco's revenue will increase by 12 percent to 17 percent annually in the next three to five years, and said spending by telcos and cable companies remains strong. Still, his 10 percent third-quarter growth forecast would put Cisco's third-quarter revenues at US$9.75 billion, short of analysts' US$10.2 billion estimate. And Cisco is watching to see whether slow tech spending will spread to Europe.
Cisco had promised 13 percent to 16 percent revenue growth for the 2008 fiscal year, and analysts had expected Cisco in 2008 to earn US$1.59 per share on US$40.34 billion in sales. "Everybody's going to be revising their estimates to see what the new guidance implies," says Inder Singh, a senior vice-president at Lehman Brothers. Cisco's diversification, with nearly half of sales outside North America, could make its stock a safe haven in a slowing economy, he says. But European phone and cable companies are putting the brakes on orders, which could bode ill for the region. "An enterprise slowdown in the United States will undoubtedly spill over into an enterprise slowdown on Europe at some point, and that's the risk," Singh says.
In Cisco's biggest businesses, sales of network-connecting routers rose 18 percent during the quarter, and its device-connecting switches were up 11 percent. In January, Cisco introduced a line of high-speed networking products called the Nexus Series, aimed at Internet video and other emerging high-bandwidth features. Sales in Cisco's newer areas, including set-top boxes, videoconferencing systems, and communications software, grew 25 percent. Chambers said the company plans to gain market share in the April quarter by spending on development and acquisitions.
Chambers' outlook has taken on an increasingly pessimistic tone in the past six months. He was bullish during a conference call in August at the close of Cisco's fiscal 2007. But his Nov. 7 warning of a drop in technology spending precipitated an autumn sell-off in technology stocks that continued into the new year. Shares of Cisco have declined 32.3 percent since Chambers' comments in November. The Nasdaq composite index, by comparison, lost 19.3 percent during the same period. Due to another set of less-than-upbeat remarks, the declines may be far from over.
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