Cisco warning signals trouble ahead in tech sector

NEW YORK - Technology companies often say their products ought to remain appealing in an economic downturn because they can save businesses money by making operations more efficient. But corporate spending apparently is being cut too forcefully for that message to get through.

Cisco Systems Inc., the first of the major technology companies to report earnings that included October, said Wednesday that orders for its computer networking equipment fell abruptly in the month. That warning echoed throughout the tech sector Thursday, with one analyst calling it the "final straw" in downgrading another tech bellwether, Hewlett-Packard Co.

October might turn out to be the worst month of the quarter, especially if credit markets revive. Daily headlines about the troubled global economy, the $700 billion bailout package and the crisis that basically dried up credit markets last month made it, in some sense, "an anomaly," said Forrester Research analyst Andrew Bartels.

Still, it appears the fourth quarter could be even more disappointing than technology vendors already had expected. Businesses are cutting back spending by putting off equipment purchases and upgrades and laying off workers. Even software, considered a safer bet because it helps companies automate costly steps, will also likely take a hit.

"It's inevitable that all technology companies, with varying degrees, will be running into the same thing," said Stephen Minton, an analyst for research firm IDC. "The reaction of businesses to the economic crisis is to stop spending money."

Technology makes up a big chunk of corporate spending. Of the total amount of money that U.S. businesses spend on fixed investments, which includes offices and factories, about 28 percent goes to computer and communications equipment and software, according to Commerce Department data analyzed by Bartels.

IDC expects very little growth in overall tech spending for the rest of the year and through most of 2009. Spending in the U.S. and Europe will likely be roughly flat, while emerging markets should continue to grow.

Products that require capital spending — such as routers, switches and computers, are expected to suffer first, Minton said.

That was reflected in Cisco's numbers. Its profit met Wall Street's expectations, but orders deteriorated as the quarter went on, with a 9 percent year-over-year decline in October. Now Cisco expects its sales in the current quarter to decline by 5 percent to 10 percent.

The forecast dragged technology stocks lower Thursday as the broader market also declined because of increasing economic woes. HP's shares lost nearly 6 percent, while chip maker Intel Corp. slipped more than 7 percent in afternoon trading.

Shebly Seyrafi, an analyst with Calyon Securities, cut his rating on HP to "Reduce" from "Add" following Cisco's warning, saying there are just too many concerns for investors. (A "Reduce" rating is better than "Sell" but worse than "Neutral.") Slowing growth in the PC market and negative currency exchange effects are just some of these worries, Seyrafi said. The "last straw," he wrote in a note to investors, was Cisco's guidance.

Cisco, the analyst noted, saw poor demand spread from the U.S. to Europe to emerging markets, and finally to Asia during the quarter. HP's large international exposure — previously an asset — now makes it vulnerable to these trends, Seyrafi said.

Software companies figure to get hit next, Minton said.

"One thing we learned in 2001, a lot of people in software said the recession won't have an effect," the analyst said. They were wrong. "What businesses do when a recession starts is they stop spending altogether."

The bright spots in the sector: Information-technology services and outsourcing — helping companies manage their computing — tend to be the least affected in a downturn, the analyst added.

Also, while it is clear that a recession will hurt the tech sector, things don't figure to be as bad as they were during the dot-com bust, which helped spark the last recession. This time around there is no tech bubble to burst. So while corporate customers are temporarily putting projects on hold and delaying upgrades to weather the economic storm, Minton said that overall, "businesses are still optimistic about technology."


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