A little more than a year ago, Paul Sagawa, an analyst with Sanford C. Bernstein & Co. Inc., made a bold call in the telecommunications industry, saying the major carriers were about to enter a period of deep capital spending cuts (see Report Downgrades Cisco and Nortel ).

Most other Wall Street analysts poo-pooed Sagawa's report, but he proved to be right on the mark. Now Sagawa appears to be calling the bottom.

“I feel good about the whole telecom sector,” said Sagawa in an interview. “It won’t be like it was in 1999, but it will be a lot better than 2001.”

As for the rest of 2002, he says that sequential growth will return in Q2 with year-over-year growth by the end of 2002.

In a research note published this morning, Sagawa told investors that he sees the telecom sector rebounding in 2002 as carriers start spending on equipment again. But he cautions that equipment companies will still have a tough first quarter, with sales picking up towards the end of the quarter. Companies will also likely provide more visibility into Q2, which is also good news, he says.

“Usually, the way to make money is to buy stocks when everyone else is most negative,” says Sagawa. “And sell when people say there is no way they can go down.”

Why is he so bullish? His reasoning is simple: “Capex can’t decline forever,” he says. “At some point they will have to start spending again.”

Capital spending declined a total of 44 percent in 2001 over spending in 2000. Each quarter it declined in the double digits, with the worst drop occurring between the third and fourth quarters when capital expenditures declined 18 percent, according to Sagawa’s report. But new spending is on the way, mostly from incumbent carriers that are supposedly improving their cash positions.

“I don’t see any reason why capex will be cut more in 2002,” he says. “And there is some possibility that with better economic conditions there could be some upside.”

While other analysts agree that the bottom of the capex decline is nearing, some predictions are a little less optimistic.

“We are probably near the bottom,” writes Steve Kamman, an analyst with CIBC World Markets in a note published yesterday. But he cautions that telecom equipment companies may not be out of the woods yet. “The telecom equipment sector is still facing potential capex cuts in 2002, but again the worst of sequential declines are likely behind us.”

Kamman believes that carriers will likely cut another 10 percent to 15 percent in their budgets for 2002. And if cash flow improves, as many carrier analysts predict, he believes this will go toward paying off debt rather than buying new equipment.

As for investments, Sagawa points out that he still sees current valuations as key determiners of performance over the next few months. While all communications stocks will likely benefit from increased spending, he says those with low valuations will see the biggest upsides. As a result, he sees Nokia Corp. (NYSE: NOK), Lucent Technologies Inc. (NYSE: LU), 3Com Corp. (Nasdaq: COMS), Palm Inc. (Nasdaq: PALM), and Nortel Networks Corp. (NYSE/Toronto: NT) (in that order) having the greatest potential in 2002. He is less thrilled about Cisco Systems Inc. (Nasdaq: CSCO), because he says the company already trades 50 percent above fair value.

Kamman also sees Lucent as a good buy in 2002.

At midday, Nokia was down 0.58 (2.16%) to 26.32; Nortel was down 0.03 (0.36%) to 8.25; and Cisco was off 0.041 (0.02%) to 20.72. Lucent was up 0.11 (1.59%) to 7.04.

— Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.com