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Online Extra: Juniper's Hot Autumn May Be Over


For Juniper Networks (JNPR), autumn 2001 has been like 1999 all over again. The company, which makes routers that direct traffic over the Internet, saw its stock price nearly triple since Oct. 1, from around $9 to $24. Much of the runup came from Juniper's report that it had beat third-quarter earnings estimates by 3 cents a share. But investors also welcomed news on Nov. 12 that it had acquired privately held Pacific Broadband, a maker of cable-modem technology, for $200 million in stock -- even though the deal would cut fourth-quarter earnings by a penny a share.

Is this the return to the heady days of networking? Not quite. Though Juniper has won plaudits for its results and its clever acquisition, investors might want to think twice before rushing to buy. Yes, Juniper beat its third-quarter estimates. But it's important to remember the company had revised them down. Its revenues of $202 million merely matched its original projections -- of flat growth for the third quarter. Juniper also reduced revenue forecasts for 2002 about 20%, from $1.15 billion to $950 million.

With a little perspective, Juniper's stock looks pretty pricey. It has a price-to-earnings ratio in the low- to mid-60s times 2002 earnings, with a three-year earnings-growth outlook of about 10%. "Investors were looking for a place to put money in telecom to balance out their portfolios. Juniper is the lesser of all evils of the telecom space," says Hasan Imam, a networking analyst at Thomas Weisel Partners.

GRIM OUTLOOK. Not even the most bearish analysts would deny Juniper's long-term prospects, however. The company is sitting on $1 billion in cash and has excellent technology and superior management. But the realities of the telecom sector cannot be ignored. Telecom spending in 2001 will plummet anywhere from 20% to 40%, depending on whose estimates you believe. The outlook remains grim for next year, with capital expenditures projected to fall an additional 5%, according to analysts at Sanford Berstein.

Less money from carriers and Internet service providers means less business for Juniper. A resulting pressure to cut prices could also affect Juniper's margins over the next 12 months. Worse, it could result in market-share losses to archrival Cisco Systems (CSCO). On Nov. 15, research firm Dell'Oro Group reported that in the third quarter, Juniper's share of the $567 million router market fell from 35% to 32%. Cisco, meanwhile, boosted its share from 60% to 65%. Investors should prepare for a bumpy ride.

To understand how carrier cutbacks could hurt Juniper in the short term, take a close look at Qwest. One of Juniper's three largest customers, Qwest orders make up better than 10% of Juniper's revenues. And on Nov. 2, Qwest circulated a memo to its contractors and equipment vendors directing them to immediately halt all work on its network while it reevaluated spending. The telecom declined to confirm how long it has put projects on hold, but it's clear that work won't pick up before next year.

BRANCHING OUT. On Oct. 31, Qwest announced it would slash capital spending 68%, to $700 million, in the fourth quarter, from $2.2 billion in the third. Next year won't be much better: Qwest estimates that capital spending will total $5.5 billion in 2002, down from $8 billion in 2001. But Friedman, Billings & Ramsey analyst Susan Kalla anticipates that it could fall to as low as $2 billion. "If the customers aren't doing well, how can you think the vendors can do well?" asks Kalla.

To make up for the slowdown, Juniper is aggressively moving into international markets. In October, it signed deals with Japanese telecom Fusion and Poland PTT, among others. But Kalla and other analysts estimate that those deals total only about $10 million each. Juniper will have to vastly increase its customer base if large carriers such as Qwest hunker down for another difficult year.

The cutback in capital spending is likely to increase downward pricing pressure, as well. Carriers such as Qwest, Level 3, WorldCom, and Williams Communications are disposing of hundreds of millions of dollars worth of equipment in the secondary market, according to analysts. Used equipment can sell for as little as 50% of original prices. Prices in the secondary market are a leading indicator for prices in the broader market because excess supply gives customers leverage in negotiations. Since early October, new-equipment prices have slid about 10%, according to Friedman, Billings & Ramsey.

"THE BIG DOG." Much of the excess equipment flooding the market is Cisco gear. During the boom, Cisco was the primary vendor to more than 600 local telecom startups -- many of which are now out of business. The glut in Cisco inventory is pushing down its average selling prices. If they keep falling, Juniper, too, will have to cut prices to remain competitive. "Cisco is the big dog, and they can set the prices in the market. That's a worry for Juniper," says analyst Imam.

Juniper admits that it faces some pricing pressure. But Marketing Vice-President Carl Showalter insists that its superior products and service will persuade carriers to spend the extra money.

Juniper does have good technology. As the need for speed has declined, it has begun focusing on providing its customers sophisticated software that will allow them to offer new services such as voice-over-Internet and virtual private networks (VPN) for large corporations. A VPN essentially creates a secure data channel over the public Internet for a company's communications that the Net otherwise cannot offer.

STRATEGIC EXPANSION. Next year, Juniper is widely expected to release a new router that would make it easier and cheaper for carriers to provide these services to their customers. "If Juniper does offer a product with 10 times the scalability of today's routers, carriers will be willing to go with Juniper -- no matter how cheap Cisco equipment becomes," says Robertson Stephen's analyst Paul Johnson. Juniper does not comment on upcoming product releases.

Juniper also is making good on its promises to strategically expand from its core business. Take Pacific Broadband, which builds standards-based cable-modem termination systems (CMTS) to let cable operators deliver advanced services, such as voice and high-speed data, over copper wires. According to Juniper Chairman Scott Kriens, the technology will enable Juniper to compete in the CMTS market, valued at $500 million this year and projected to reach $1.3 billion by 2005. "Juniper has to grow. This acquisition lets them play in a new, untapped market," adds Johnson.

Overall, Juniper is doing many things right to hold up in tough conditions. The problem is that the company has little control over when and how fast telecoms will start spending again. So, while you can still love the company, investors aren't likely to see triple-digit runups in the stock anytime soon. By Jane Black in New York


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