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The Road to Prosperity That Never Was

As the technology bubble deflates, the severity of mismanagement, and malinvestment grows more evident. Last Friday, Nortel announced that it is will not meet expectations, but didn’t end it there. Nortel guided analysts down on future revenues as well. Nortel has reduced guidance for 2002 revenues to $20 billion, and believes it will be profitable. So far Wall Street is buying it. Robertson Stephens is one exception. It has penciled in only $17.3 billion in revenue with a loss of $0.13 per share. Its previously forecasted revenue of almost $31 billion with a profit of $0.49 per share. For a little prospective, revenue for 2000 topped $30 billion, and was around the $17 billion level in 1998. 2000 could very well be a decade-long high watermark. Not only is Nortel reducing future prospects, but it also recognized that it needs to get its financial house in order. Nortel will take a charge of almost $17 billion, with the majority ($12.3 billion) attributed to the write-down of goodwill associated with three previous acquisitions. The rest is due to exiting some businesses and layoffs. This will chop Nortel's $29 billion of equity by more than half.

What is truly amazing is the fact that throughout the telecom boom Nortel never booked a profit. The last year Nortel made money was 1997. Only one quarter in the last 13 (14 if you count the June quarter which they just pre-announced for) was profitable. Nortel spent the whole boom increasing capacity and purchasing other companies to grow, grow, grow. And that it did. From 1997 (its last profitable year) to 2000, Nortel almost doubled revenue, up 95%. But income declined from $811 million to a loss of almost $3 billion last year. The company would like investors to think it make money, but pro-forma earnings don't count.

Nortel is far from alone in its view of future prospects. Tellabs was the talk of the day with its announcement that it will not meet Wall Street's expectations. Additionally, Tellabs slashed its revenue forecast by over 35% for the second quarter. Richard Norebaert, CEO of Tellabs, admitted "I don’t see us returning to the unbridled demand that we had in the last few years." He added "That was an aberration." This is starting to become the consensus view among the tech and telecom companies. Also yesterday, Teradyne announced its first loss in over 10 years for its second quarter. Its outlook leaves no doubt on the condition of their business. "This downturn is unprecedented in both breadth and depth." He also noted that conditions have "continued to deteriorate in every segment. Both our customers and Teradyne are facing unprecedented level of uncertainty."

Dell Computer finds itself in a pickle. The Wall Street Journal reported that Dell has written put contracts on 96 million shares with an average price of $44. With the stock trading at $23, it represents a $2 billion loss. For a little prospective, Dell’s shareholders equity is only $5.5 billion. And no, this loss is not already reflected in the balance sheet, yet. This is just one more example of how well everything works when the market keeps going up. Companies are able to utilize an expensive stock to supplement salaries and income as well.

It truly amazing how this boom and bust has transpired. An easy way to view it is by thinking of 1999 and 2000 as aberration, just like the CEO of Tellabs said. I've long thought that 1999 and 2000 was a period marked by a demand shock (fed from the credit bubble) for technology. Unfortunately, everyone thought that the trend had changed and didn't realize that the boom was self-fulfilling and unsustainable. The common view was that companies needed to upgrade technology equipment, get broadband access in order to increase productivity. Plus the newfound wealth of individuals, from increasing asset prices, led to an increase of technology purchases by individuals. Therefore companies like Nortel invested money back into the business thinking that demand was just starting. Just a year ago mobile handsets sales were expected to be around 620 million units this year. Just today the chairman of Infineon said "Given actual production levels at the moment, 400 million units is extremely ambitious."

Just for kicks last year's estimates for 2002 and 2003 were 824 million and 1,086 million respectively.

The telecom bubble was also responsible for the booming real estate as well, and now that is starting to suffer. Commercial real estate is usually one of the first segments to feel a pinch, especially when tenants are going out of business. Here in Dallas, new space is coming available at the same time that companies are vacating office space and offering it for sub-lease. In the two suburbs here, Plano and Richardson, that house most of the technology and telecom companies in the metroplex there is 1.4 million square feet of new office space coming to market. During the first quarter companies vacated over 90,000 square feet and have another 212,825 square feet that are not being used. This has pushed rents down 1.26% in the first quarter. This is similar to other technology-saturated areas of the country.

Even media companies benefited greatly from the technology boom. Just think of all the Nortel ads you saw and thought "Why are they advertising here, I'm not going to go buy a OPTera Long Haul 1600 Optical Line System anytime soon." All these "stock selling" commercials added up to huge growth for media companies. Also the tight labor market increased their help wanted ads. Now that revenue has vanished and reduced forecasts are just as prevalent. Here are a few quotes from the larger newspaper companies:

"We really have no visibility, at this point, to when improvement is going to begin." – Dow Jones & Co.

"We’re not holding out much hope for the second half of the year." - E.W. Scripps

"It has been worse every month and I have no reason to think we’ve hit bottom." – The Washington Post

However, there is one exception. Knight Ridder thinks that "While turnaround is premature, we seem to have hit bottom… We see the third quarter as being better than the second and the fourth being better than the third."

MediaWeek tracks the number of advertising pages in magazines. The drop off experienced in news and business magazines is astonishing. BusinessWeek has seen its number of ad pages decline by 35% year-to-date compared to last year. But that pales next to The Industry Standard. Ad pages at the technology magazine are off over 70% on a year-to-date basis and the latest issue contains 83% less ad pages than the issue one-year ago.

Workers cannot be forgotten. Workers were fought over and bid away from companies using large salaries and lucrative (at the time) stock options. These workers also experienced above average wage gains year over year. This led to a lifestyle than not only was based on current wages, but on wages they assumed would be there in the future. This mentality, not limited to the tech sector, is responsible for a portion of the current consumer debt problem. Consumers got accustomed to large raises and stretched themselves thinking that there would not be a problem later. Now these workers are starting to get laid-off. Not only have they created lifestyles that were above their means, but also were getting paid above market wages. Unfortunately it could take years before wages return to the levels that some have based their lifestyle on.

This has all transpired as the economy actually expanded. When consumers start to pull back and actually curtail spending, repercussions will be felt throughout the economy. The housing market will be key going forward. Growth is starting to stall, but still remains at very high levels. The additional aspect of the housing market is the huge multiplier effect that accompanies it. Anyone that has purchased a house knows the once you hand over the down payment, that is only the first of many expenditures.

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