Telecom Equipment Makers Flying High

Telecommunications equipment companies produce the guts that make telephones, mobile phones, fax machines, Internet networks and other systems move and switch phone calls and data at blindingly fast speeds.

And moving things ahead at a rip-roaring pace is also the perfect metaphor for the equipment makers’ stocks this year.

A quick look at the price-to-earnings multiples in the accompanying chart illustrates the point: These stocks are among the market’s top guns. The sector’s 37% surge so far this year is fifth-highest among the 89 groups that make up the Standard & Poor’s 500 index, though the stocks have pulled back in tandem with other technology shares (and the broader market) in recent sessions.

The telecom equipment stocks are up sharply in response to the companies’ sizzling gains in revenues and earnings over the last two years, propelled by a boom in capital spending by the Baby Bell regional phone companies and by the burgeoning number of long-distance carriers.

Even Southeast Asia’s current economic problems haven’t slowed them much, said analyst Tim Luke of Lehman Bros. “The key drivers for the equipment guys are China and, to a lesser extent, Japan,” he said. Those regions, along with North America and Europe, have been robust enough “to offset the slowdown in Southeast Asia.”

Cases in point: Mobile-telephone systems giants LM Ericsson of Sweden (ticker symbol: ERICY) and Nokia of Finland (NOK/A), which garner 20% or more of their total revenue from Asia, “have still managed to post strong growth,” Luke said.

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But has the easy money been made in these stocks? After all, the shares are carrying price-to-earnings ratios (based on their expected 1998 earnings) that are 50% or more above the overall market average P/E. If the companies’ profits dip even a bit below expectations, their shares could get hammered by unforgiving investors--as is happening now with many computer-related stocks.

And there’s plenty of opportunity to come up short. Competition is fierce as the players jostle to offer the latest technologies to telecommunications providers, and to invade turfs that have been dominated for years by one or two companies.

There are also the proposed mergers among the giant telecommunications companies--the deal by Pacific Bell parent SBC Communications Inc. (SBC) to buy Ameritech Corp. (AIT) for $56 billion is just one--which would reduce the number of potential customers for the equipment firms.

Indeed, shares of Ciena Corp. (CIEN) recently tumbled after the maker of phone network gear said it’s unsure when orders from WorldCom Inc. (WCOM) will resume. WorldCom had suspended orders until it closes its $37-billion purchase of MCI Communications Corp. (MCIC).

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Ciena holders were already nervous because the company this year has faced growing competition from phone network giants Lucent Technologies Inc. (LU)--the equipment arm that AT&T; Corp. spun off in 1996--and Northern Telecom Ltd. (NT).

Those two also are encroaching on the turf of Cisco Systems Inc. (CSCO), the powerhouse in moving data across the Internet and in other computer network systems. Lucent and Northern Telecom have recently unveiled products for transmitting voice over data networks and are aggressively peddling those products to telecommunications carriers looking to move voice and data on routes outside their conventional phone lines.

Yet despite all these trends, Wall Street still likes a selected number of the equipment companies and believes their growth will remain steady enough to justify the prices these stocks now command.

Take Cisco, a stock that’s soared a stunning 87% a year on average since 1990 as the company exploited and fostered the Internet’s soaring popularity. Despite that remarkable feat and its growing battle with the likes of Lucent, George Kelly of Morgan Stanley, Dean Witter, Discover & Co. still has a “strong buy” on the stock because he expects Cisco to keep posting compounded annual earnings growth of 30% for the next five years.

He’s also set a price target of $90 a share for Cisco over the next 12 months; the stock currently trades at $73.56 on Nasdaq.

Lehman’s Luke also likes Cisco, noting that “as a dominant sector leader [with] expanding share in a growing market, Cisco remains our sole buy recommendation in the data-networking industry.”

Meanwhile, Lucent--which on Monday quickly settled a strike with its two major unions (story, D14)--has been on a tear to the point that some analysts believe the stock has gotten ahead of itself, even if the company’s fundamentals remain bullish. Philip Sirlin of Schroder & Co. recently downgraded Lucent to “hold” simply because of the stock’s run-up.

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Others, though, are urging investors to keep buying Lucent, in good part because they see the pending telecom mergers not as reducing the number of Lucent customers, but as a potential way to expand the company’s reach.

For example, Lucent counts SBC as one of its big customers for telephone access equipment, and it might try to “leverage its close relationship with SBC” and use the merger “to improve its presence as a supplier . . . to Ameritech, where it has provided a relatively low share” of Ameritech’s equipment, Luke said.

Tellabs Inc. (TLAB), a flourishing maker of big switches that route traffic over telephone networks, “could also emerge as a potential beneficiary of the SBC-Ameritech combination,” because Tellabs also has an “exceptionally strong relationship with SBC,” Luke said.

In the meantime, Tellabs’ flagship Titan line of digital circuit-switching gear continues to drive the company’s growth. First-quarter profit and revenue jumped another 38% and 33%, respectively, from a year earlier, and were ahead of even the high-end estimates on Wall Street.

Jefferies & Co. analysts Douglas Ashton and Connie Fang have a “buy” on Comverse Technology Inc. (CMVT), a maker of equipment for messaging, voicemail, fax and other communications systems. The company is enjoying strong revenue growth, a healthy order backlog and a strong balance sheet.

Comverse also had a big first quarter, with earnings and sales far above analysts’ expectations. It should get an added push from its recent purchase of Boston Technology Inc., another provider of voice and Internet messaging systems, the Jefferies analysts said.

A few players in the wireless sector are also high on analysts’ lists. Ericsson, which builds products for both mobile and wired communications networks, gets a “buy” rating from Mirva Anttila of CIBC Oppenheimer, owing to “strong orders for mobile systems” in the second half of 1998.

One of Ericsson’s toughest rivals in that business is Nokia, which is also a leading manufacturer of cellular telephones. Angela Dean, analyst at Morgan Stanley, said Nokia--trading at 27 times estimated 1998 earnings--is “an undervalued play in the telecommunications industry,” and she recently lifted her 12-month price target to $77. Nokia’s American depositary receipts currently trade at $63.25 on the New York Stock Exchange.

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If you, well, switch from phones to cable television, Scientific-Atlanta Inc. (SFA) gets high marks from several Wall Streeters because of its role as a leading provider of set-top converter boxes for cable operators.

Right now the cable industry is increasingly shifting to advanced, digital converters from conventional analog boxes, and Scientific-Atlanta is gearing up to ship more of the digital models.

Eric Buck of Donaldson, Lufkin & Jenrette rates Scientific-Atlanta a “buy” not only because of “a strong ramp-up in digital set-top converter shipments in calendar 1998,” but also because the company sports a “historically modest” price-to-earnings multiple of 26 based on estimated 1998 earnings.

Times staff writer James F. Peltz can be reached at james.peltz@latimes.com.

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Dialed In

Telecommunications equipment stocks are among the market’s top performers this year. But as their price-to-earnings multiples show, investors expect them to keep posting exceptionally strong profit growth. Some of the major players, ranked by year-to-date percentage change in stock price:

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Ticker Monday % change Stock symbol close from 12/31 P/E* Nokia** NOK/A $63.25 +82% 27 Lucent Technologies LU 68.94 +73 43 LM Ericsson** ERICY 27.63 +48 31 Northern Telecom NT 64.31 +45 34 Cisco Systems CSCO 73.56 +32 42 Comverse Technology CMVT 50.00 +28 23 Tellabs TLAB 65.81 +25 37 Qualcomm QCOM 50.31 -1 33 Ciena CIEN 51.38 -16 38 3Com COMS 24.00 -31 35 S&P; 500 index +12% 23

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*Price-to-earnings ratio based on analysts’ consensus estimates of 1998 per-share earnings.

**American depositary receipt

Source: Bloomberg News