By John Dix

04/23/01

Given the gloom and doom that settled in after the stock market bubble burst in April 2000 and the economy began heading south, it's surprising the Network World 200 finished the year with revenue up 14%. That's the same heady growth enjoyed in 1999.

Sales for the group - the 200 largest U.S. network companies based on revenue - reached $909 billion, a $110 billion gain from the year before. This is the second year in a row NW200 companies collectively increased their intake by more than $100 billion.

But profits tanked, dropping to $63 billion, 9% lower than the $69 billion the NW200 posted in 1999. Expressed as a percentage of revenue, NW200 profits were 6.9% last year vs. 11.6% for 1999. Nearly half of the companies - 91 of them - reported losses in 2000.

Of course, the NW200 spans a range of companies, from $88 billion behemoth IBM at the top to $60 million Mobius Management, a comparative mouse at the bottom. It is a list of haves and have-nots.

As a rule, the heavy hitters typically enjoy slower revenue growth but are more profitable. The 69 NW200 companies with revenues of $1 billion or more saw sales climb 12% last year and profits scale even more, to 16%.

The 131 companies with less than a billion dollars in revenue enjoy faster growth, but many are still in investment mode or are outright floundering. These companies saw sales spike 47% last year, but losses climbed to $23 billion from $5 billion in 1999. Of the 91 companies in the red last year, 77 fall in this group.

Added up, it would appear the souring economy didn't go bad fast enough to ruin the top-line numbers of the NW200 last year. But it certainly squeezed profits for the smaller guys and left the group peering furtively over the horizon at 2001.

Where the spiraling economy took its toll is in stock value. At the height of the irrational exuberance last year, the value of the NW200's outstanding shares passed $5 trillion. Today, 46% of that wealth has evaporated. As of March 9, 2001, the market capitalization of the NW200 was $2.7 trillion. While that's still an oversized number - close to the $2.9 trillion gross domestic product of Japan - the loss of market muscle will curtail the efforts of acquisitive companies.

Take Cisco. The network kingpin swallowed 23 companies in 2000, including big Web switching fish ArrowPoint for $5.7 billion. But Cisco will find it hard keeping pace, given that the value of its stock is down $322 billion from this time last year to $148 billion today. (Cisco's market value actually reached $555 billion at one point last year.)

Sinking stock aside, Cisco fared well in 2000. Other core infrastructure players had a tougher go of it. But the industry most in turmoil was telecom, which was rocked from bottom to top.

Where to start? C. Michael Armstrong's grand plan for AT&T disintegrated, forcing the CEO to break up the company - again. At WorldCom, after his audacious play for Sprint flopped, CEO Bernie Ebbers followed AT&T's lead by cleaving his company in two. Qwest Communications completed the US West acquisition, leaving only three of the original seven Bell companies standing. One of those three, Bell Atlantic, merged with GTE to form a national company, Verizon, and waded into long-distance in two markets. The competitive local exchange carrier (CLEC) party exploded with virtually no warning, leaving the industry shaky, but perhaps stronger. And a host of DSL upstarts went belly up.

The long-distance industry is still beset by the faster-than-anticipated decline in business and consumer voice revenue. AT&T says its business service revenue for 2000 climbed 3.3% to $28.4 billion primarily on the strength of data/IP and outsourcing sales, but falling voice revenue offset that growth. While voice traffic is growing by "mid-single digits," AT&T reports, price competition is reducing long-distance voice revenue at a "low teen rate."

On the consumer side, AT&T's voice service revenue declined 9.5% to $18.9 billion for 2000. Worse, it dove 9% from the third quarter to the fourth, and consumer voice sales were off 15% from fourth quarter 1999 to the same period in 2000.

This is, after all, why Armstrong has scrambled to get the company into broadband cable. He needs a revenue stream to make up the difference. Those efforts are slowly beginning to pay off. AT&T broadband sales climbed 10% last year to $9.6 billion. The company says it has 1.1 million high-speed data subscribers (adding 3,800 per day), some 560,000 broadband telephony customers and 2.9 million digital video customers.

But the convergence is apparently not happening quickly enough to offset the weight of the voice loadstone. AT&T, second on the NW200 list, finished the year with sales up 5% to $66 billion but profits down 43% to $3.1 billion.

With profits in decline and the company's stock swooning, Armstrong took radical action in October when he broke the company into four pieces: AT&T Wireless (which already had its own tracking stock), AT&T Broadband, AT&T Business and AT&T Consumer. It's likely that the Broadband, Business and Consumer units also will get their own tracking stocks one day.

One of the brightest spots on AT&T's balance sheet is wireless. Sales last year were up 37% to $10.4 billion. Although AT&T Business only grew 3.3%, you can find strengths here, too, if you drill down. Revenue for IP services, including VPN offerings, grew in the "mid-40%" range in the fourth quarter last year, the company reported. "On a combined basis, packet services (frame relay, ATM and IP) grew around 40% for the quarter."

Data is also the strong suit at WorldCom, which broke in two last November in an effort to box off the slow-growth voice business. The company still carries the WorldCom name but has two separately traded tracking stocks: WorldCom Group, which includes the high-growth data businesses and international; and MCI Group, which serves consumers, small business and dial-up Internet users.

A quick glance at the two units' results makes it clear what fueled the need for change. After reworking the books to reflect the new organizational structure, WorldCom Group finished the year with revenue up 19% to $22.8 billion and net income of $2.9 billion, up from $2.3 billion last year.

By comparison, MCI Group finished the year with sales of $16.3 billion, essentially the same as the year before, and net income of $1.8 billion, slightly up from $1.6 billion in 1999. But the fourth quarter in 2000 was bleak. Revenue fell to $3.8 billion from $4.2 billion in the same quarter in 1999, even as the company eked out net income of $125 million.

Stitched together, WorldCom, seventh on the NW200, finished the year with sales up 9% to $39.1 billion. If WorldCom had won governmental approval for its bold plan to acquire Sprint last year it, would have weighed in at roughly $56 billion, up there with the biggest telecom players.

For the first time, carriers hold three of the top four NW200 slots: AT&T (2), Verizon (3) and SBC Communications (4). The latter two achieved this rank through mergers. Verizon is the byproduct of Bell Atlantic (which bought Nynex in 1999) merging with GTE last year. And over the years SBC, the old Southwestern Bell, has acquired Pacific Telesis, Ameritech and Southern New England Telecommunications, among other properties.

Qwest took US West out of the Bell picture when it completed that acquisition last July, leaving just two mega-Bells - $64.7 billion Verizon and $51.2 billion SBC - and the less acquisitive BellSouth, a $26.1 billion company.

Make no mistake, the mega-Bells are big. Verizon claims it serves one out of every three telephone lines in the country and two-thirds of the top 100 markets. Through its joint venture with Vodafone, it offers wireless service in 96 of the top 100 markets.

When federal and state regulators let the mega-Bells get serious about long-distance, the landscape could change drastically. Verizon and SBC officially started to dabble in long-distance last year, but neither have much to show for it yet.

The biggest change in the local exchange market was the CLEC collapse. Many of the companies booming last year are either on the brink or already bust, victims of huge debts run up when demand for the services they were building seemed limitless. Reality has since settled in, and the funding needed to execute each company's grand vision has dried up.

Two years ago, Winstar Communications, a CLEC using wireless broadband technology, was one of the two fastest-growing NW200 companies. Last year, the company did fairly well saleswise; it ran revenue up 70% to $759 million. But like other CLECs, it was bleeding red ink in 2001 - a staggering $1 billion. Last week the company threw in the towel and declared bankruptcy.

Another CLEC straddled with debt and struggling to raise cash is Teligent, 149 on the list. Last fall, Teligent said it had enough cash to fund operations into the second quarter, ending June 30. One more barometer of health: As of this writing, its stock is trading at 44 cents.

ICG Communications, 84 on the NW200 last year, and e.spire Communications didn't make it. ICG filed for Chapter 11 bankruptcy in November, and e.spire, although making this year's NW200 at No. 103, followed suit in March.

Issa Mikel, an analyst with The Yankee Group, says when the dust settles only a handful of strong CLECs will be left, and that's good. "There was a lot of overcrowding," he says, adding that the survivors will have diversified service offerings and less debt. "I'm optimistic about the CLEC future."

Not even a focus on data can save some of these competitive upstarts. Witness the failure of many of the DSL carriers. Covad Communications, the fastest growing NW200 company last year, didn't even make the chart this year because in its tenuous situation, it hasn't yet officially closed the books on 2000.

While Covad is still in business, its stock is hovering near $1. Its primary competitors aren't faring any better. Rhythms NetConnections is hanging on by a shoestring, its stock floating around 25 cents. And after filing for bankruptcy in January, NorthPoint Communications sold its network to AT&T last month, laid off 70% of its employees and lost its top executives.And these are the big national DSL players. Many of the smaller regional companies, such as Vitts and HarvardNet in the Northeast, have called it quits. Mikel is less optimistic about DSL-only carriers because the margins are simply too thin.

The failure of the CLECs and DSL carriers has had a ripple effect on the infrastructure players, many of which gave the upstart carriers ridiculously attractive terms on equipment when the future for these carriers was still bright.

Lucent blames some of its current woes on that misstep. The company's sales were up 10% to $33.8 billion last year, but profits dove 75% to $1.2 billion. The company is scrambling to reorganize under a new CEO and just posted a $1 billion loss for the first fiscal quarter of 2001.

But even Cisco, which managed to drive sales up 55% last year to $18.9 billion, only mustered 32% profit growth, partly because of the credit problem.

Although Cisco and most other equipment suppliers now demand the equivalent of cash on the barrelhead for new equipment, the bigger problem is the soft market. If you take CEO John Chambers at his word, times are bleak. Last week Cisco announced that third-quarter revenue would be down about 30% compared to second-quarter revenue. The firm also said it would lay off 8,500 people. Chambers has saidthe next two quarters look soft, too.

Saleswise, routers and switches each account for 40% of Cisco's business, with access products weighing in at 13% and the remainder falling into "other."

When Cisco first set its sights on telecom as a new market opportunity, everyone asked, "What chance does little Cisco have against the likes of Lucent, Nortel and big international players Siemens and Ericsson?" While Cisco still lacks some of the technology to go up against the biggest players, and the world isn't retreating from circuit switching quite as fast as some once expected, the difference in size is eroding.

Five years ago, Cisco was a $12 billion company and Nortel $22 billion, a difference of 83%. Said another way, Cisco would have had to nearly double in size to catch up. Today, Cisco is $18.9 billion and Nortel is $30.3 billion, a difference of 60%. You can bet Nortel CEO John Roth is constantly looking in his rearview mirror. In Securities and Exchange Commission documents, Nortel lists Cisco as a primary competitor in almost every major market segment.

Because Lucent spinoff Avaya can't seem to articulate a good enterprise data network strategy, Nortel is really Cisco's biggest enterprise competitor. The enterprise hunk of Nortel's business is only 18% of sales, but that equals an impressive $5.3 billion. Stealing a page from Cisco's book, Nortel has been on an acquisition binge for the past three years, evidence of which shows up in its revenue and profit: Sales were up a staggering 42%, but the cost of all that activity resulted in a $3.5 billion loss for 2000.

Since February, Nortel has announced it would cut 15,000 jobs.

For the most part, 2000 was kind to many of the core enterprise infrastructure players. The NW200 numbers for Cabletron look promising but, because of the company's odd February fiscal close, are essentially for a period in 1999 so have to be discounted. But the firm's third-quarter results for the period ending Dec. 2 also show advances. Revenue for the four operating companies Cabletron formed out of its existing business in 1999 were up 10% to $265 million.

The bulk of that revenue is from Enterasys, the company that sells enterprise network gear. Sales were up 8% to $206 million in the quarter. Enterasys' year-over-year growth for the quarter was up 20%.

3Com's drastic reorganization, on the other hand, isn't going so well. After spinning off Palm in July, giving up on the enterprise core switching market and making a brief run at the consumer Internet appliance business, 3Com is yet again retreating. It, too, has an odd fiscal year (ending in June), so the numbers in the chart only tell half the story. While fiscal 2000 showed sales down 17% to $4.3 billion and profits of $674 million, more telling are the third-quarter results posted last month.

Third-quarter revenue was down 18% to $629 million, and the company reported a pro forma net loss (which excludes some restructuring charges) of $122.8 million. 3Com laid off 1,200 employees in February and, with the announcement of these quarterly results, said it would close its recently established consumer Internet appliance business. CEO Bruce Claflin is now looking for a way to save $1 billion by the end of fiscal 2002.

Two brighter spots on the infrastructure scene are Gigabit Ethernet players Foundry Networks and Extreme Networks. Both reported strong 2000 results, even if their stock prices have plummeted.

At its 52-week high on March 21, 2000, Foundry's shares were trading for $146. As of press time, they were going for around $9. That, even though Foundry, 101 on the NW200, drove sales up 182% last year to $377 million while pulling down a profit of $88 million. Extreme, 118 on the list, pumped sales up 167% to $262 million and brought in profits of $20 million. Its stock, which peaked in October at $128, was trading at $17 at press time.

Echoing Cisco's gloomy outlook, Foundry said last month that first-quarter product orders were lower than anticipated because of "decreased or delayed capital spending."

On the computing infrastructure side of the market, the most notable change was plucky Dell leapfrogging Microsoft on the NW200 list, jumping up to the 13th slot.

Dell posted another incredible year, with sales up 38% to $25.3 billion and profits up 14% to $1.7 billion. Sales of the company's enterprise systems, including servers, workstations and storage gear, were up 81% last year, and notebook sales climbed 61%.

Dell claims that online sales generate nearly 50% of revenue, a whopping $40 million per day, up from $14 million per day in 1999.

At Compaq, the third largest computer maker and No. 6 on the NW200, the financial picture looked better in 2000 but not quite as rosy as for arch-rival Dell. New management put in place in 1999 ratcheted revenue up 10% to $42.4 billion and drove expenses down 3% but only mustered a paltry $569 million in profits. That's 1% of revenue and the same amount of profit the company posted the year before.

Five years ago, Compaq had revenue of $20 billion and a profit of $1.3 billion, a margin of 7%. It's had a rocky time since its Digital Equipment acquisition in 1998; Compaq closed that year with a $2.7 billion loss. History will not look kindly on the Compaq-Digital marriage.

Hewlett-Packard, No. 5 on the NW200, may be the mover to watch this year. The company is newly focused under CEO Carly Fiorina, who is coming up on her second anniversary with the company. Sales for 2000 were up 15% to $48.8 billion and profits up 6% to $3.7 billion.

In the company's annual report, Fiorina says HP has overhauled much of its server product line and that this effort began to pay off in the second half of 2000, when corporate account business was up 28%.

With the decks cleared (HP spun off much of its test and measurement business previously), the company can start to focus its considerable weight on its strengths, everything from midrange servers to high-end Unix boxes, Ethernet network equipment and storage-area network products.

Hardware revenue at IBM, the granddaddy of computing infrastructure and perennial No. 1 on the NW200, was flat for 2000. While CEO Louis Gerstner must worry about that, he is somewhat insulated because he has transformed IBM to the point where 37% of revenue comes from services today. Hardware is 43% of sales, software 14% (the remaining 6% falls in "other").

IBM says it signed contracts last year for $55 billion in outsourcing deals, with 60 of those being worth in excess of $100 million and six exceeding $1 billion.

Tucked inside Global Services is what IBM flatly calls "the largest business and technology consultancy" in the industry. The company's 50,000-plus consultants billed more than $10 billion in revenue last year.

Added up, IBM sales only inched up 1% to $88.4 billion, while profits climbed 5% to $8.1 billion. The company says international currency exchange rates depressed its revenue gain, which otherwise would have been 4%.

In software, IBM notes a few things of interest. One, middleware is hot. It says sales of its MQSeries messaging software were up more than 60%, and sales of its WebSphere e-commerce middleware tripled year over year.

IBM also says it is investing $1 billion in Linux and dedicating 1,500 programmers "to enable every IBM hardware and software product" for that open source operating system. The goal, IBM says, is "to accelerate its adoption as a platform that can support heavy-duty enterprise workloads."

Perhaps efforts such as IBM's backing of Linux have dragged Microsoft's returns down from the stratosphere. Microsoft sales were only up 16% last year to $22.9 billion, compared with the 29% and 28% growth the company enjoyed for the prior two years.

Even the release of Windows 2000 didn't distract attention from the biggest software story of the year - the rise of the application service provider (ASP) market. While our bold 2000 prediction that many pure-blood ASPs would grace the NW200 this year hasn't come to pass, Interliant (No. 143) remains on the list, and USinternetworking (No. 166) joins it.

Interliant finished the year with sales up 236% to $158 million and a loss of $151 million, while USinternetworking's revenue climbed 208% to $110 million on a loss of $175 million.

But the failure of many ASPs has the market questioning the sector as a whole. This, combined with the fall in technology stocks, has whipsawed these two companies. Shares in either company can be had for around $1 today.

Rarely has a technology concept come on so fast and then self-corrected so quickly. The good news is that this should leave a few stronger players, although the consolidation process probably hasn't fully run its course.

Speaking of corrections, it is hard to remember a time when the network market as a whole slammed on the brakes as dramatically as it did at the end of 2000. SmartMoney.com says Cisco"s Chambers saw evidence of a slowdown in December and the sky darken even more in January. Then "the lights went out," SmartMoney.com quotes Chambers saying. "There"s no question we got knocked on our tails."

While some would have you believe this is a passing spring storm, others say the climate might not improve until the fourth quarter. Hopefully the NW200 companies have the hatches battened down.

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