Merrill Lynch Expects Q4 2004 6% Growth for Communications Equipment Sector

January 7, 2005

Financial advisory firm Merrill Lynch has released communications-sector financial analysis for the fourth quarter of 2004.

A report from analyst Tal Liani and team says the company expects the communications equipment sector to grow 6% sequentially in the fourth quarter, much slower than the 12% growth in the same period of 2003. The report attributes the difference to “more muted seasonal patterns throughout 2004 vs. strong 4Q seasonality in 2003.”

As I understand it, this is a reference to the natural market rhythms that take place throughout the year. (For example, I would guess that there’s a drop in August in many business sectors because people are on vacation.) So when ML refers to “muted seasonal patterns,” I think they mean that the seasonal fluctuation was flatter, that prices did not vary as much as the previous year, or perhaps as much as analysts would expect.

It seems to me that attributing the lower growth rate to muted seasonal patterns is more of a description of what happened than a true attribution – the analysts don’t really tell us what the cause is. But I’m probably splitting hairs here, the analysts probably did not have room in the summary I received to explain the causes of the muting of the seasonal patterns, I might not understand it if they did – and there might be only eight people in the world besides me who would really want to know anyway ….

Analysts say that gross margin for the sector is expected to be 50%, with operating margin 18%. They estimate sequential net income growth of 12% for the sector.

Following are some sub-sector highlights, quoted from the Merrill Lynch research report. They include some fascinating tidbits about various players in the communications industry.

Wireless

“We believe Motorola will meet or slightly beat our 4Q estimates, attributed to positive seasonality, strong shipments in the US evident by our store visits, better than expected component orders, and good reception of the high-end Razor phone. Overall, we expect 4Q handset shipments to rise 10% sequentially, compared to stronger seasonal patterns in prior years (20-25%) attributed mainly to a strong first half of 2004. With Qualcomm's pre-announcement of the quarter's results and given the accounting changes that impact this quarter's financials, we expect very few surprises. In software, we expect Amdocs to report quarter inline with expectations for good F2Q guidance, driven by revenues from Cingular/AT&T Wireless.” (Source: Merrill Lynch research report)

Data Networking

“We believe that the data networking companies have noticed some recovery in demand in the US in the second half of 4Q (post elections), with Extreme, Foundry, and F5 expected to report good results. We believe, however that these positive surprises are already factored into the street's expectations. Although Cisco's quarter only ends in January, we believe the company could meet its 1%-3% seq. growth guidance, as the weakness noticed at the beginning of its quarter has reversed with current trends suggesting flat to slight growth. Lastly, we expect Juniper, which derives c.75% of revenues from carriers, to meet or beat expectations, benefiting from positive seasonality (although more muted than in prior years). However, we highlight the risk with the 2005 margin guidance, given the street's high expectations vs. Juniper's need to invest in its enterprise initiatives.” (Source: Merrill Lynch research report)

Wireline

“We expect 4Q results to show more muted year-end seasonality, with a modest 4% (ex-Nortel) seq. top line growth compared to 12% (ex-Nortel) growth seen in 2003. In our view, wireless and Voice over IP will continue to be growth drivers, offset by softness in traditional wireline circuit switching and broadband access businesses. We expect VoIP pure play AudioCodes to report strong results, benefiting, among other things, from a demand recovery at Nortel. Tellabs could also positively surprise, as strong demand at Cingular could temporarily reverse the declines seen in the last two quarters. However, we expect the negative trends to continue throughout 2005. Lastly, we expect Lucent to report in-line results, with strength in wireless offset by declines in circuit switching.” (Source: Merrill Lynch research report)

AB -- 1/7/05