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Next Level Cut in Half
Shareholders in Next Level Communications were greeted with a 55% loss yesterday on news of an analyst downgrade. Whether the market overreacted is difficult to determine right now, but investors may find out next month when Next Level's largest customer briefs analysts on its plans.
By
Chris Rugaber (TMF RFK)
August 25, 2000
Investors in Next Level Communications (Nasdaq: NXTV) received a rough lesson yesterday on the power that analysts can sometimes wield over the stock markets. Shares in the company plummeted more than 50% after a Lehman Brothers analyst reduced his rating on the company from "buy" to "neutral," citing concerns over future sales of the company's products to its principal customer, Qwest Communications (NYSE: Q). The stock's collapse eliminated almost $4 billion in market capitalization.
Next Level makes digital subscriber line (DSL) equipment, which expands the capacity of the copper wires that connect customers' homes to the larger telecommunications network. DSL service enables telecom providers to offer broadband Internet access, normal phone service, and digital video over existing telephone lines.
What happened yesterday?
Qwest is important to Next Level because the telecom carrier purchased regional Bell operating company (RBOC) U S West earlier this year. U S West has been Next Level's best customer, as it implements its "Choice TV" service in Phoenix, Arizona. Choice TV offers 180 digital video and audio channels, as well as broadband Internet access, and uses Next Level's equipment to offer these services over its phone lines. Choice TV is an excellent example of the kind of bundled services the RBOCs hope to offer as more and more cable companies add high-speed Internet access, and even local telephony, to their offerings.
Nevertheless, the Lehman Brothers' note indicated that Qwest may de-emphasize the DSL business going forward, in favor of business data offerings. Qwest responded by saying that "a determination has not yet been made on the [DSL] business," and Next Level said it had received no indication from Qwest of its future plans.
Did the market overreact?
As such, it's difficult for investors to determine at this point whether the market has overreacted. On the one hand, Next Level is quite reliant on its business with U S West, and admitted as much yesterday. Last quarter, the company received 67% of its revenue from U S West, and while the company has attracted plenty of new customers, at least one analyst anticipated that U S West's DSL business would provide about half of Next Level's sales next year.
On the other hand, Qwest may not cut back on its DSL initiatives. According to Bloomberg News, the company has permits to expand its "Choice TV" service into two counties in Colorado, and its business in Phoenix has been a success. In fact, Cox Communications, the local cable provider, stated that competition from Choice TV caused it to miss sales and cash flow targets in the most recent quarter.
What's also interesting is that Qwest's review of its business, and the potential slowing of U S West's DSL initiative, has been known for some time. As long ago as March 22, then-U S West chair Solomon Trujillo told Bloomberg News that the company's Choice TV initiative could be slowed as a result of its acquisition by Qwest. Qwest CEO Joseph Nacchio also noted that the company would have to review its business after the U S West deal closed in June. However, soon afterward, Next Level signed an agreement to provide DSL equipment to Bell Canada, and the stock soared upward in response. As a result, investors and analysts did not seem to take the company's late-March comments as a warning sign at the time.
Perhaps the risks surrounding the company's business with U S West are just now finally being priced into the company's stock. Either way, a clearer answer may come on September 7, when, according to a report from Reuters, Qwest plans to discuss the progress of its business review with analysts. If the company does decide to de-emphasize its DSL initiatives, then the market may not have overreacted after all.
Your Turn:
Did any Next Level shareholders notice the March 22 news and wonder about it at the time, or take it as a warning? Let us know on the company's discussion board.
Related Link:
Next Level's Q2 earnings release
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