NEW YORK (CNNfn) - Stocks in the high-flying optical networking sector were trampled Wednesday after Nortel Networks Corp.'s third-quarter revenue fell short of analysts' expectations.
The sell-off among makers of optical networking components and semiconductors spread to other technology shares, causing the tech-heavy Nasdaq composite index to close down 190.22 points, or 5.6 percent, to 3,229.57. It was the Nasdaq's third straight loss and the index's eighth-worst point decline on record.
The Philadelphia Semiconductor Index lost an even more severe 7.2 percent.
Optical networking, which is the transmission of data using photons of light carried over optical fibers instead of electrons carried over copper wires, has been one of the hottest sectors in the market over the past year, with many stocks in that area more than quadrupling over the past 52 weeks.
"The whole networking equipment area was the last bastion of high P/Es," said John Forelli, senior vice president at Independence Investment Advisors. "A lot of these stocks were still at nosebleed valuations."
Nortel (NT: Research, Estimates) actually beat Wall Street's earnings forecasts by a penny per share late Tuesday. The Brampton, Ontario-based communications equipment company reported third-quarter earnings, excluding special items, of $574 million, or 18 cents per diluted share, up from $314 million, or 11 cents per share, in the year-earlier quarter. Analysts had expected a profit of 17 cents per share, according to earnings tracker First Call.
Revenue increased 42 percent to $7.31 billion. While most companies of Nortel's size would be thrilled with that rate of revenue growth, the company's sales fell short of analysts' expectations of roughly $7.5 billion for the quarter. While Nortel's optical revenue increased 90 percent from last year, it declined slightly from the second quarter. The company attributed the slowing optical revenue to excessive inventory buildup at telephone companies that were being worked off.
Stocks in the optical area, which were selling for very high price-earnings multiples and were "priced to perfection," as analysts say, didn't react well to the news.
Nortel (NT: Research, Estimates) closed down $18.31 at $45, a 29 percent drop. Nortel stock traded 123.6 million shares, more than eight times above its normal volume. JDS Uniphase (JDSU: Research, Estimates) plunged $24.06 to $71, a 25 percent loss. Ciena (CIEN: Research, Estimates) dropped $27 to $108.37, and Corning (GLW: Research, Estimates), which makes optical fiber, lost $16.62 to $76.87
"Nortel's results had one big surprise," Merrill Lynch analyst Tom Astle said. "Optical revenue declined sequentially. Ouch! Optics is Nortel's growth engine and it has been growing at over 20 percent sequentially in previous quarters."
 "We believe that this is an unusual temporary event and gives a unique opportunity to buy a significant market leader on weakness," Astle added.
CS First Boston analyst James Parmelee reduced his fourth-quarter sales estimate for Nortel to $8.45 billion from $8.9 billion, while keeping his earnings-per-share estimate at 26 cents.
"We are comfortable with our $39 billion-plus sales forecast for 2001, given Nortel's strong product portfolio in optics, wireless, access, and next generation switching," Parmelee wrote in a research note.
SG Cowen analyst Drew Peck said in a research note issued Wednesday that optical networking is not a fad, and that investors shouldn't look for problems in the sector that don't exist.
"Optical networking is exploding, and the market will experience tremendous growth during the next decade," Peck wrote. "As we noted with Digital Subscriber Lines, few important technologies experience smooth and steady adoption cycles. Customers cannot accurately calculate the exact rate of adoption, and the inevitable result is inventory imbalances."
Semiconductor companies are hit also
Companies that make semiconductors used in optical networks also got pounded Wednesday morning.
PMC-Sierra (PMCS: Research, Estimates), which makes chips used in broadband communications infrastructures and high-bandwidth networks, lost $37.75 to $161.12, a 19 percent drop. Applied Micro Circuits (AMCC: Research, Estimates), a chip company in the same area, lost 25 percent of its value, plunging $50.31 to $148.
While SG Cowen's Peck issued reassuring words about optical networking in general, he downgraded Applied Micro Circuits to "buy" Wednesday in response to the Nortel announcement.
"While the company has seen no negative trend in its bookings activity, the Nortel remarks suggest a downturn is inevitable, although probably not until the first quarter of 2001," Peck wrote in a research note. "Unfortunately, stocks selling at more than 100 times multiples don't fare well in the face of any negative trend."
Even at the reduced price of $148, Applied Micro Circuits is still selling for about 141 times Peck's fiscal 2001 earnings per share estimate of $1.05 and 105 times his fiscal 2002 estimate.
Separately, Maxim Integrated Products (MXIM: Research, Estimates), a maker of chips that detect temperature, pressure, or sound and convert those inputs into digital signals, plunged $20.25 to $57.19 after it was downgraded by CS First Boston to "buy" from "strong buy."
"While we continue to believe in long-term prospects for Maxim, we are more cautious on the near term inventory and booking trends we are seeing," said CS First Boston analyst Michael Masdea in a research note. "Growth in both internal and distributor inventories have outstripped revenue growth in the last two quarters."
Amazon, Siebel, Compaq earnings
Web retailer Amazon.com was an exception to the general downward trend in tech stocks Wednesday. Its stock rose $2.31 to $31.88 after the company reported better than expected third quarter results.
For the third quarter, ended Sept. 30, Amazon (AMZN: Research, Estimates) reported a pro forma operating loss of $68 million, or 25 cents per share, compared with a pro forma operating loss of $79 million, or 26 cents per share, in a year earlier. The mean analyst estimate was for a loss of 33 cents per share, according to First Call, which tracks earnings estimates. Amazon.com's U.S. Books, Music and DVD/Video segment pro forma operating profit was $25 million. Revenue for the quarter rose 79 percent to $638 million from $356 million. Merrill Lynch analyst Henry Blodget had estimated that Amazon's third-quarter revenue would be $600 million.
Separately, Compaq (CPQ: Research, Estimates) rose $1.15 to $28.15 after the company reported a third-quarter operating profit of 30 cents per share, exceeding Wall Street's expectations, as sales rose 22 percent from the same period last year. Executives at Compaq, the world's leading supplier of personal computers, said the company remains in a strong revenue position moving into the fourth quarter, but they noted that weakening currency in Europe will trim a few cents off its bottom line.
Piper Jaffray analyst Ashok Kumar issued a bearish research note on Compaq Wednesday.
"Growth rates are inflated due to easy compares in the year ago period," Kumar wrote. "However, the segments that do matter -- business critical servers, storage and services (about 35 percent of the mix) -- posted almost no growth (+3 percent year/year). Due to the secular decline in PC hardware profitability and the lack of focus on enterprise hardware and services, it is questionable if there is a sustainable turnaround under way."
Separately, business software maker Siebel Systems lost $3.94 to $108.81, even though the company reported on Tuesday third-quarter revenue and net income that blew past analyst estimates. San Mateo, Calif.-based Siebel (SEBL: Research, Estimates) reported net income of $71 million, or 14 cents per share, compared with pro forma net income of $27.3 million, or 6 cents per share, for the same period last year, representing increases of 161 percent and 133 percent, respectively. The mean analyst estimate for the quarter was 11 cents per share, according to First Call. Revenue for the third quarter surged 131 percent to $480.9 million from $208.5 million for the same period in 1999. 
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