Posted 01/2001
Business and Finance
Sharpening Focus
Vendors Hone Strategies to Strengthen Position in a Fuzzy Market
By Becky Bracken
Telecommunications equipment vendors have been weathering some tough times. With capital spending slowing significantly and their service provider customers facing difficulties of their own, vendors such as Lucent Technologies Inc. (www.lucent.com), Nortel Networks Corp. (www.nortelnetworks.com) and Cisco Systems Inc. (www.cisco.com) are fighting to hold their ground while attempting to figure out who their customers should be and how best to meet those customers' needs.
While Lucent seems to have been hit the hardest, all three companies are facing major changes and potential problems if they can't compete in such a dynamic and rapidly evolving marketplace. While the tough times are likely to continue in the near term, investors and company officials seem encouraged by long-term prospects.
Debra Mielke, president of telecommunications consulting firm Treillage Network Strategies Inc. (www.treillagenet.com), says she thinks most of the vendors' problems are due to a lack of what she likes to call the "F" word: Focus. "You've got to stick to what you're going to be when you grow up. It's about focus," Mielke says.
Lucent has had particular problems with the "F" word of late. Late entry into the optical market, and overall inefficiencies in management and decision-making have put Lucent squarely behind the eight ball. Lucent officials seem to agree, and the company is launching major initiatives to improve the company's overall performance.
"Our issues are ones of execution and focus," says Michelle Davidson, Lucent spokeswoman. "They are fixable, but the fix will not be achieved in one quarter. Fiscal year 2001 will be a transition and rebuilding year for Lucent. We're implementing major changes at every level to turn the company around. We are conducting an intense review of our product portfolio. We're consolidating our corporate infrastructure as we move from a multidivisional company to one with a single focus on broadband and the mobile Internet."
As of Sept. 30, Lucent spun off their enterprise networks business, now called Avaya Communications Inc. (www.avaya.com), and announced plans to spin off their microelectronic business as well. Lucent also agreed to sell its Power Systems business to Tyco International Ltd. (www.tycoint.com). The vendor hopes that by unloading these divisions, it can focus solely on providing what it calls a "triple play" of optical, data and wireless networking for the service provider industry.
Lucent in October also ousted its chairman and CEO, Richard McGinn, and replaced him with the company's former chairman and CEO, Henry Schacht. The management change was a direct result of the company's slow move into the optical networking business, as well as problems with other internal processes.
Lucent officials remain optimistic about the ability to turn the company around, but concur there aren't going to be any overnight fixes. Most of the changes at Lucent will be in an effort to streamline operations.
Davidson identified three specific causes for the company's recent weak fiscal fourth quarter. "We saw lower-than-expected revenues and gross margins in optical business due to being late to market with our OC-192 product, and the effect that had on the entire product cycle," Davidson says. "Second, we experienced lower-than-expected revenues from higher-margin switching products. And third, specific credit concerns in the emerging service provider market. It led us to increase our reserves for bad debt related to trade receivables."
To add insult to injury, Lucent was forced to restate their less-than-stellar fiscal fourth quarter results because of issues related to how and when the company recorded proceeds from its sales. The restatements knocked about $125 million off Lucent's quarterly revenue and two cents from its per share earnings. Though the $125 million is a small part of the total $9.4 billion in revenue it posted for the quarter, analysts believe that the restatement is just another event that may cause concern about the company's ongoing operations.
While some of these issues can be laid at Lucent's own feet, other problems, such as a faltering emerging service providers' market--which is a big chunk of equipment vendors' business--are affecting all players in the industry.
Although Cisco and Nortel haven't been forced into fundamental internal changes like Lucent, each has their own strategy for assuring growth. Nortel remains confident that their focus on optical Internet, wireless Internet, local Internet and e-business solutions should continue to provide strong growth. Cisco, on the other hand, is like a shark on a feeding frenzy, acquiring one company after the next. For example, in November, Cisco acquired Radiata Inc. (www.radiata.com) and Active Voice Corp. (www.activevoice.com), bolstering Cisco's abilities in the next-generation wireless network and unified messaging for small to medium-sized enterprise businesses, respectively. All told, Cisco acquired 22 companies last year.
In the Oct. 30 Bear Stearns & Co. Inc. (www.bearstearns.com) report titled "Weaker Revenue Growth Could Signal Difficult Times Ahead," authors Wojtek Uzdelewicz and Michael Gargano report that Nortel Networks is a good long-term investment bet.
"Longer term, Nortel remains one of the best companies to capitalize on the emerging broadband telecom equipment market," they say in the report.
However, there is concern about a glut of inventory and outstanding financing balances to shaky startups that could eventually affect pricing. "Nortel indicated that there was an inventory buildup among some operators due to double ordering in a response to earlier product shortages," according to the report. "Additionally, the majority of operators that reported so far continue to post slowing revenue growth and are under pressure to bring down their cap ex [capital expenditures] spending."
Nortel indicated that its financing exposure was $1.4 billion and financing commitments were at $3.1 billion at the end of the third quarter, a slight increase over the end of 1999, which could put a strain on Nortel's performance.
While Cisco has been the best able to limit its financing exposure, all of these companies are being forced to cope with slowdowns. In some cases, startup customers are unable to survive long enough to pay off aggressive financing packages offered by equipment providers, and that may mean big problems for the vendors in the future, says Richard Nespola, president and CEO of The Management Network Group Inc. (TMNG, www.tmng.com).
The solution, he says, would be for equipment providers who offer aggressive financing packages to take a more aggressive role in the business development of their customers. When these companies provide aggressive financing, they become de facto investors in these startups. Nespola says it only makes good business sense to take a very active role in making sure these companies are doing everything they can to stay competitive and in business.
"What I think they should have done to hedge their bets is to get more intimately involved in developing the business strategies and models to go along with their network investment," Nespola says. "I think if they had helped these companies with product development and better business acumen, I think more of these companies would have been success stories, rather than the problems that they're running into."
Cisco, most of whose business is still on the enterprise side, is in a better position in this respect. The company is selling a great deal of networking equipment directly to corporate America, rather than to the service provider market. This enables Cisco to shift gears to fit an evolving market much more readily than its counterparts. "Not that they don't have good products for service providers, they're just not as exposed as Nortel or Lucent," Nespola says.
But, Nespola adds, it is also important to take into account that these equipment providers achieved a lot of their initial success based upon product quickly flying out the door. So, if they had been more stringent in their financing, perhaps they never would have been as successful in getting their products deployed.
"It's one of those chicken-and-egg things," Nespola says. "If, for example, there isn't a source of funding for these startups, then they have nobody to sell equipment to. It makes good business sense. If they continue to elect to do aggressive equipment financing or taking equity stakes in startup models, they can't be passive in their involvement."
Mielke says unpaid bills won't be the ultimate downfall of equipment providers. "I think they'll get some [investor] money, though there might be some losses. I think the market is punishing them for not showing big gains. It's about expectations. The expectation in the market is that all of these guys would have these huge gains. Cisco is the one who set that expectation."
Those expectations have undoubtedly been dashed in light of market conditions over the past several months, but turning things around may not be impossible.
While Lucent, Nortel and Cisco each have their own individual struggles, "these are good companies. The markets are brutal, Darwinian--the strongest will survive," Nespola says. "[The equipment vendors] are long-term players, but they can't just do anything by themselves; they have to make sure that the markets bounce back."
