By Sam Jaffe
It's an interesting word -- bellwether. It once stood for the castrated sheep around whose neck the shepherd hung a bell so it would lead the flock. Today, just the latter part of that meaning persists. Every industry, sector, and imaginable grouping of stocks has a purported bellwether. It's supposed to forecast with dependable accuracy where other stocks in the sector are headed.
For the past few years, Cisco Systems (CSCO ) has been the technology bellwether, a symbol of the tech boom. That status was reaffirmed on Aug. 24, when the stock shot up 8.9% on news that it's reorganizing from 3 to 11 groups, including divisions focused on optical, storage, voice, and wireless businesses. In characteristically herd-like fashion, the Nasdaq went along for the ride, rising 73.7 points, or 4% for the day.
It wasn't just the restructuring that triggered the upsurge. It was also the timing. Chambers intimated to the media that the reorganization was a signal Cisco thinks the bottom has arrived and that sales should pick up soon. The market assumed that the same must be true for all tech stocks.
Cisco's bellwether status persisted through several dips and rises of the market. It was one of the first Silicon Valley tech stocks, and it was the one that everyone paid attention to. For a brief and shining moment in March, 2000, Cisco was the largest-capitalized stock in the market, worth $599 billion. "It was the be-all and end-all stock. People said you had to own it -- no matter what the price," says Bill Meehan, chief market strategist for Cantor & Fitzgerald.
Alas, in these troubled days for the tech sector, Cisco has been reminding investors more of the canary in a coal mine than the sheep in a meadow. Its precipitous decline has tracked Nasdaq's 60% fall from its peak over the past year and a half. At its closing price of $18.25 a share on Aug. 24, Cisco's market cap stood at $133 billion, and its reputation for delivering a never-ending chain of brilliant quarterly earnings has evaporated.
That led some to question Cisco's status as bellwether of the overall technology industry and specifically the Internet. "Now, it's just another stock," asserts Meehan. After all, it produced only $22 billion in revenues last year, almost one-sixth of GE's (GE ) sales. Cisco's enormous market cap was buoyed by the tech bubble, and it will probably be a very long time before it returns to those lofty levels.
In the face of such cold reality, market interest in Cisco has clearly waned. It used to be that the week before Cisco's earnings report came out, newspapers, radio, TV, and Web sites were abuzz with speculation about what the numbers might say about the state of the economy. Yes, there's still a degree of anticipation, but the tech-laden Nasdaq responded more to Ciena's (CIEN ) bad news in mid-August than it did to Cisco's bad quarter, which has been reported the week before. Cisco declines comment on the vitality of its bellwether status. Cisco spokesperson Mojgan Khalili points out that CEO John Chambers likes to remind investors: "We execute on our business and let our stock price take care of itself."
And for the most part, the company has retained its market-leader status even if that market is mostly in a shambles. Cisco has an essential monopoly in the enterprise market -- large corporations -- which gives investors a window into corporate buying habits. It also remains a major player in the telecommunications market. When service providers start thawing out their frozen spending plans, Cisco will be one of the first beneficiaries. And the market will follow.
Corporations that decide to spend more on tech usually expand their networks first. Behind every corporate network is Cisco equipment that needs to be added to, replaced, or upgraded. If you want to know when corporate technology spending will start increasing, listen to what Chambers says about his projections for Cisco's sales. Says Meehan: "You have to pay attention to Cisco because it touches everything and everyone that has anything to do with the Internet."
RETURN OF DEMAND.
True enough. So why is Cisco looking so pained right now? Despite the stock-price boost on Aug. 24, things are bad these days. Very bad. Cisco's sales for the fourth quarter, which ended in July, were $4.3 billion, compared to $5.7 billion the year before. In terms of income, the company ended at break-even. For the same period the year before, it rolled up a profit of $796 million.
Is the agony nearly over? CEO John Chambers said in a conference call explaining the fiscal fourth-quarter results that he didn't foresee a dramatic recovery in 2001's second half. But he did say at some point demand would return, and "someone in this industry, whether it's us or another company, will once again enjoy 30% to 50% sales growth." And you can still assume that a Cisco rebound likely means a broad rebound in the downtrodden tech sector.
Let's not forget: Despite the massive downturn in Cisco's fortunes, it still has a price-to-2002-earnings ratio of 68.5. Investors still consider it to be a growth stock, even though the company isn't forecasting any growth the next few quarters. Because of that growth premium, the stock will likely be more volatile than those with more down-to-earth p-e's. And that volatility will simply be an exaggerated meter reading of the technology sector.
MOUNTAIN OF CASH.
One last thing to keep in mind about Cisco: It's financially healthy. While other would-be bellwethers such as Lucent (LU ), Yahoo! (YHOO ), and Amazon.com (AMZN ) are struggling along, Cisco is sitting on about a $12 billion pile of cash. If sales were to suddenly stop altogether, this company could still function for at least four quarters -- if not longer.
That's not to say as soon as the money starts to flow again, investors should expect Cisco to inflate in the same manner it did during the height of the tech bubble. "Often, investors reflexively turn to companies that served them well in the last upturn," says Credit Suisse First Boston strategist Mike Mauboussin. "That almost never works out. As cycles of innovation have contracted, so have the reigns of market leaders."
Being a bellwether doesn't mean you'll stay one forever. But for now, despite the past 18 months' humbling experiences, the tech flock still follows Cisco.
Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column
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Edited by Beth Belton