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Analysts on Q4: Cautious Optimism

A smattering of earnings results are in for the fourth quarter (see Redback Trims Losses, CFO, Intel Reports Q4, and Alcatel Sees Sales Uptick), but the large incumbent telecom equipment suppliers have yet to report. Some analysts are looking deeper into earnings season with guarded optimism.

Following its upgrade of the entire wireline equipment sector to neutral from negative last week, a Lehman Brothers note out today predicts that three major vendors in the space -- Lucent Technologies Inc. (NYSE: LU), Nortel Networks Corp. (NYSE/Toronto: NT), and Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA), to be precise -- will meet and even possibly slightly exceed both top-line and bottom-line expectations for the December quarter.

Steven Levy, Lehman analyst and author of the report, says that while he doesn’t expect to see any growth in the space before 2004, the losses have begun flattening out, and equipment vendors should start benefiting from growing stability in capital spending among service providers.

"It has been a long time since the telecommunications equipment industry has been so silent in the three weeks before earnings release season,” he writes in the note. “This is likely to be the first reporting season in a long time when none of the major companies have proactively announced disappointing results.”

Not everyone is upbeat about the upcoming earnings results. Merrill Lynch & Co. Inc. analyst Simon Leopold, who issued his own predictions for the earnings reports last week, points out that it is easy not to disappoint when the bar has been set so low. “Maybe we’ve bottomed, maybe we haven’t,” he says “We’re probably stuck at the bottom for a long time… We don’t see any catalyst for robust growth.”

Even if carrier capital spending for the quarter improved, that wouldn't necessarily mean higher revenues for the vendors, Leopold observes. “Despite the possible sequential increase in carrier capital spending by as much as 30% for the major carriers, we anticipate the vendor revenue will be down, or at best flat,” he writes in his note. “We continue to believe that returns from investment in the communication equipment sector will continue to be dismal.”

Levy, of course, isn’t predicting massive growth either. In a note last month, he also warned that improved capital spending among service providers won’t automatically translate into improvements in equipment revenues (see Analysts Predict More Capex Cuts). However, he says, having companies simply making their numbers is a welcome change. “Let’s walk before we can run. We’ve been flat on our back for a long time.”

In his note, Levy forecasts that Lucent, which will announce earnings on January 22, will report $2.15 billion in sales for its December quarter -- right in the middle of the company’s anticipated range of $2.05 billion to $2.28 billion. He also states that he expects the vendor to have sales of $2.4 billion for its March quarter -- a little lower than the company’s $2.5 billion forecast.

"We project 22% gross margins and a normalized loss of $0.21 per share for the December quarter, both of which are improvements from the September quarter and the same period a year ago," Levy writes.

As for Lucent’s share price, Levy states that Lehman feels the company is fully valued at its current price of $1.73 a share, and that the analyst firm expects the price to go to $1.75 by the end of 2003.

"We would not be surprised, however, to see noticeable near-term upside in LU shares if the earnings season does not contain the usual bevy of negative surprises for technology companies in general," he writes, "and if the company can continue to rebuild confidence in investors that it is successfully addressing liquidity issues and remains on track towards a return to profits in fiscal 2003. “

Tellabs, which will also announce its earnings on January 22, should beat Lehman’s sales estimate of $290 million by about $10 million, Levy writes. He also expects the company to have a lower loss per share than Lehman’s forecast of 3 cents.

"We would also not be surprised to see operating expenses finish below our forecast of $150 million and management’s guidance for sequentially flat operating expenses of $153 million, given restructuring moves announced in mid 3Q and management’s traditional pattern of exceeding cost control expectations," he writes. He says that Tellabs needs gross margins of around 44 percent to 45 percent and operating expenses of $140 million to $145 million to break even.

Tellabs, currently trading at $9.52, is overvalued, Levy writes, maintaining Lehman’s $5 target for the company. However, he writes, "[We] would not be surprised to see them trade even higher in the near term if the company’s profitability outlook continues to improve, especially if the company can come close to breakeven EPS in 4Q."

Nortel is also overvalued, in Levy's opinion. While the company is trading at $2.44 a share today -- $2 above its stock price in mid-October -- Lehman maintains a $1.75 year-end target for the company. "[A]lthough, as with LU shares, a positive earnings outlook and a favorable technology investment environment could cause NT shares to rise despite traditional valuation metrics being stretched," Levy writes.

When Nortel announces its earnings on January 23, it is likely to beat Lehman’s forecast for sales of $2.4 billion, gross margins of 39.5 percent, and a loss of 4 cents per share, Levy writes. He estimates that Nortel will return to positive EBITDA in its fourth quarter. "Profitability is widely expected to be much improved," he writes.

Compared to Lucent, he says, Nortel’s liquidity seems to be in better shape. "We would look for additional information from Nortel as part of its December quarter earnings release to further reassure investors of its previous goal of having more than $2 billion in cash at the end of 2003," he writes. "Of course, investors would also be comforted if Nortel’s profitability appears better than expected."

All in all, according to Levy, the upcoming earnings reports should indicate that the worst is finally over. "We have a sense that we’re going to break the vicious circle that we’ve had for a couple years," he says, pointing out that carrier spending seems to have stopped its downward plunge.

— Eugénie Larson, Reporter, Light Reading
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