If the outlook for technology companies before September 11 was particularly glum, the view is now decidedly worse. One of the persistent problems that was plaguing tech concerns even before the terrorist attack is the so-called overhang of excess inventory. Secondary markets are still awash with new, or nearly new gear, which has been dumped on the market by failed dot.coms and bankrupt telephone carriers.
Nearly every maker of hardware is experiencing the dual pain of lackluster demand exacerbated by dramatic price-slashing in the gray market. Among the hardest hit by this tidal wave of second-hand gear that is being unloaded by bankrupt or financially troubled customers is Cisco Systems. Indeed, some of the gear still in its original packaging, changes hands at prices that are as little as half of what Cisco would charge for new equipment.
You can even buy the stuff on eBay. On Thursday, there more than 2,300 auctions were listed selling Cisco gear. That's 13 times the number for Nortel Networks' Bay networks and nearly eight times the number of auctions for equipment from 3Com and Lucent Technologies' Ascend.
"That's material," quips analyst Susan Kalla, of Friedman Billings Ramsey. "The difference between Cisco and Nortel should be more like four times."
Corporate information technology decision-makers were drastically cutting back on their technology purchases prior to the terrorist attacks, and there are indications that the tragic events have cast such a pall over the economy that those few executives who were poised to spend are now putting away their wallets, too.
A bigger problem for Cisco is the collapse of the competitive local-exchange carriers. The CLECs, as they're known, were huge customers before the equity markets turned on them, making it impossible to raise new cash to build out their networks. So, many of these start-ups turned to their vendors for financing or leased gear from third parties, or from the vendors themselves. Cisco, which was particularly aggressive in offering financing, has since reclaimed much of the gear that was sold to the now-bankrupt carriers.
A lot of analysts now say that tech companies such as Cisco can't even begin to turn the corner until the gray market inventory is burned off. And based on that assumption, it isn't surprising to hear that Cisco may be attempting to expedite that process by destroying perfectly good second-hand gear and components.
"Cisco is taking back a lot of its own equipment. Tons and tons," says John Lynch, a principal of Asset Recovery Center, an Eatontown, New Jersey based firm that buys and remarkets gear from bankruptcy liquidations. "And they are just crushing it."
Lynch contends that Cisco has hired Houston-based Waste Management to destroy certain critical parts, known as supervisor cards, that are integral to Cisco routers. Without the cards, routers are basically useless, he says. "They are the brains of the machines." Lynch says.
A Cisco spokesman who is an executive in the finance department denies that his company has hired Waste Management to dispose of gear. A Waste Management spokeswoman told Barron's that her company has asset recovery facilities in Arizona where electronics are recycled. She said that Waste Management handles asset recovery work, through a third party for Cisco but declined to elaborate further.
Why would Cisco destroy perfectly good equipment? The answer may lie quite literally in the margins. If Cisco's networking gear becomes an asset in bankruptcy proceedings, the company will get back just cents on the dollar for its claims. Plus, it will have to compete with the gray market in its own equipment for sales. But if Cisco yanks its high-margin equipment back and destroys it, the company eliminates a gray-market competitor, thus allowing it to earn far more on the sale of new equipment than it would make on proceeds of a bankruptcy settlement.
While Cisco's spokesman acknowledges that the company does destroy some of its own equipment, he insists the practice only takes place in rare cases, such as when leased gear is returned after the expiration of a lease term.
We've destroyed an infinitesimal amount of equipment coming back on leasing (contracts), and only gear that was unsellable," the spokesman says. He adds that the company is not destroying good equipment. It would be a disadvantage for us to destroy good equipment," the spokesman argues.
What's more, the spokesman says that Cisco is not reclaiming as much equipment as some - such as Lynch - claim. "Our leases are a tiny blip," he says.
Asset recovery's Lynch says he isn't surprised by Cisco's details. He and his partner Mark Magee make a handsome living buying Cisco's and other brands of networking equipment from bankruptcy courts and reselling it at auction. By buying new software licenses and getting Cisco to recertify the second-hand equipment, Lynch says he is able to sell fully warranted products at prices that are often half of what Cisco would charge new.
Nor is there any dearth of fresh inventory. "I've got truckloads of Cisco gear coming," says Lynch.
The netherworld of asset recovery isn't a tidy business. Lynch says Cisco's service reps sometimes drag their feet when he wants the company to recertify gear. In one case, when he was selling gray-market gear to major Cisco customer, Lynch says he had to use the customer to pressure Cisco to recertify the gear. "Cisco risked the loss of a major customer that has bought hundreds of millions of dollar's worth of gear. (The Customer) is under budget constraints, too, and let Cisco know about it, "Lynch says, Cisco wouldn't comment on the assertion.