ADC: A Telecom Highflier That's Back to Treetop Level Barely a quarter of the way through 2001, and 2000's heady performance already seems like it was a lifetime ago
Just three months ago, Rick Roscitt left a top-level executive post at AT&T to become chairman and CEO of broadband services and fiber provider ADC Telecommunications, a fast-growing company that was riding the surge in demand for high-speed Internet connections. A rising star at Ma Bell with a reputation for making businesses grow fast, Roscitt aimed to work the same magic at ADC. But he hardly had time to memorize his new phone number before the telecom-equipment maker's fast-growth timetable vanished with a poof in the telecom meltdown.
Roscitt's story at ADC (ADCT
) is typical of how technology companies in the S&P 500 are faring in this extended slump. ADC rose like a rocket to the No. 20 spot on the BW50 list of top performers in 2000. But this year, its boosters flamed out as phone companies reduced spending in ways that affect most of ADC's product line.
In January, as a result, ADC pegged the top end of its revenue growth at 15% in both 2001 and 2002. That was down from its previous projection of 20% and seems likely to go lower: On Mar. 28, the company said it expects second-quarter sales to be $650 million to $700 million, down from $771 million a year ago. It also said it will eliminate 3,000 to 4,000 jobs by October, on top of 3,000 cuts it has already announced, leaving it with 17,000 to 18,000 employees. Citing the weakened economy, the company predicted a loss equal to 10 cents to 15 cents a share for its fiscal second quarter ending Apr. 30, vs. profits of a 10 cents a year ago. Its stock dropped nearly 20% on the news, to $8 and change.
TWO-PART ANSWER. Even before that announcement, the market had taken its revenge on ADC. Last July, before Wall Street lost its appetite for telecom shares, ADC reached a 52-week high of $49. Investors bid it up on the theory that a surge in demand for broadband access to the Internet would boost sales of ADC's core products. Since then, the stock has drifted down steadily, leaving investors with a dilemma. With analysts' 52-week targets now ranging from $5 to $15, do they buy in now or wait for ADC to fall further? There's probably a two-part answer: For those who like to buy and hold, ADC may merit a closer look. Those intent on making a fast buck might want to seek their fortunes elsewhere.
ADC's growth will rebound along with the economy, analysts believe. They note that, already, the company is performing better than most telecom equipment makers. And ADC is intent on improving that: As part of a wide-ranging restructuring that's well under way, it's getting rid of unprofitable products, reducing overlap between divisions, and slashing research and development expenses.
In particular, the company is whipping into shape its broadband transport and access division (which makes hardware and software that allows for fast data transfers). The goal is for that unit, with $230 million in fiscal first-quarter revenue, is to break even, for the first time, in the company's fiscal fourth quarter. That task will be made harder because it now looks like much of ADC's projected revenue shortfall will be in that division. Before the latest cuts, a Lehman Brothers' report forecast that cost-cutting will reduce ADC's operating expenses by $150 million. That's a chunk of change for a company with projected sales this year of $3.2 billion.
GLOBAL DEMAND. In the meantime, ADC is trying to bolster its sales by focusing on the high-growth areas of the telecom market, such as cable telephony equipment, which continue to enjoy strong demand in spite of the economic slowdown. According to Lehman Brothers, ADC gear that's used to patch equipment from different companies into one network should keep selling well -- especially since demand for such products is growing faster internationally than in North America. The company's sales abroad rose by 68% year-over-year in the January quarter and accounted for 27% of ADC's first-quarter revenues, according to Josephthal & Co. ADC Chief Financial Officer Robert Switz says ADC's goal is to get 30% of total revenues from non-U.S. markets in 2001, a target the company reiterated in its Mar. 28 announcement.
Yet, ADC has much work to do before its troubles are over. Charles Pluckhahn at Stephens Inc. believes the company may still be overvalued. "ADC is really a mixed bag," he says. While its fiber-optic and copper-connectivity systems and components are best-sellers, ADC's broadband products have been losing money, Pluckhahn explains.
Tim Savageaux of WR Hambrecht & Co. agrees. He recently downgraded its stock to neutral -- Wall Street code for sell. Savageaux labels the company a "little Lucent," meaning it has many older, slow-growth products. Indeed, ADC's sales of software and hardware products that enable higher data-transfer speeds on networks grew 5% in the first fiscal quarter, somewhat shy of the speed of light.
INVENTORY MOUNTAIN. Worse, Switz says ADC's 36% growth in fiscal first quarter was to some extent "artificial" -- higher than it would have been normally. A year ago, phone-service carriers and resellers ordered all the equipment they could, anticipating shortages that never materialized. Since then, order rates for many ADC products have dropped to as low at 50% of what the company had anticipated, according to a recent report from Josephthal, which rates ADC a hold.
As a result, its inventory of unsold products jumped to $536.9 million at the end of the fiscal first quarter, vs. $486.1 million last October. "While we believe that ADC has a very promising future, we'd like to see some signs of improvements in the company's business" before giving it a buy rating, says Josephthal analyst Lawrence Harris. It might take until the end of the company's fiscal third quarter for inventories to be worked out of distribution channels, Switz predicts.
"The company's near-term focus has to be to get through this period of challenging spending in North America," says Harris. He predicts that the company will record earnings per share of 3 cents in 2001 and 30 cents in 2002. That's well below what most analysts expected just a few days before the Mar. 28 warning.
Analysts still believe that Roscitt can guide the company through these turbulent waters. This much is clear, though: It'll take some expert navigation for ADC to reach a safe harbor.
Kharif covers telecom and networking for BusinessWeek Online in New York Edited by Alex Salkever
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Copyright 2001, Bloomberg L.P.
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