Earnings offer further evidence of telecom downturn

High-speed Internet companies Covad Communications and Copper Mountain Networks posted quarterly financial results last week that provided further evidence that the communications sector is mired in a slump.

Meta Group says market setbacks experienced by digital subscriber line companies demonstrate that the communications sector is being affected by some of the same market dynamics that are influencing dot-com firms. see commentary

Ongoing concerns about a slowdown in spending on networks and equipment, particularly among smaller communications competitors, appear to have been bared out by the financial reports--and could have a ripple effect.

Covad shares were pounded last week after the company posted earnings that fell short of expectations. The company blamed the shortfall on Internet service provider customers that could not pay their bills. As a result, Covad plans to curtail its nationwide network construction, which is nearly completed but could have an effect on equipment makers such as Nokia, a Covad supplier.

Copper Mountain Networks makes similar high-speed Net access gear for Covad competitor NorthPoint Communications, among others. Copper Mountain issued a fourth-quarter profit warning because of the decrease in spending across the communications industry.

Related digital subscriber line (DSL) companies, including NorthPoint, Rhythms NetConnections and Centillium Communications, saw their stock prices hammered on the news, though some of the share prices have since bounced back.

"I think people have doubts about the business plans of these companies in terms of competing with" the Baby Bells, said Adam Guglielmo, an industry analyst at TeleChoice, a communications consulting firm. "Do these smaller players have the resources to compete with the larger companies?"

The concern is part of a broader trend toward decreased spending among CLECs, or competitive local exchange carriers, the smaller phone and Internet providers that resell the Baby Bell local phone networks. This genre of companies, including GST Telecommunications, ICG Communications and mPower Communications, have spent heavily to build new data and voice networks. But as capital investment markets have dried up, investors and Wall Street have begun looking for profits, not more expensive growth efforts.

"Once the tech market downturn began, new criteria were established," said Covad CEO Robert Knowling. "Wall Street began looking unfavorably on capital-intensive businesses with long lead times to break even...A year ago the 'buy side' group was interested in growth at all costs."

Although the high-profile executive departures, profit misses and the rest have not affected all of the communications players, many of them are being lumped together regardless.

"I think we're a sector right now where good news is passé and anything that looks negative gets pounced on," Knowling said. "About four months ago the Street started looking more carefully at heavy capital spending."

Analysts agree, saying that investment dollars have tightened for the whole sector. But some say that perspective is shortsighted.

"What the analysts are not understanding is that this is still a supply constrained business," Knowling said. "We're still getting more orders than we can chew."

Still, many industry experts say the CLEC market is undergoing a shift that includes exploring new business models and embracing consolidation to gain the size necessary to compete, among other changes.

"I think really what we're seeing is a shakeout in terms of who has got a truly sustainable long-term plan," Guglielmo said.