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For this tech analyst, the future is in bandwidth
Seth Spalding says demand for high-speed data transmission has led to an abundance of
companies ready to deliver these services. Among his top picks are JDS Uniphase and
Adaptive Broadband.
By Eneida Guzman
The future of the Internet will be defined in large part by the key issue of bandwidth -- how much voice, image
and data can be gathered or transmitted in how much time. The good news, says Seth Spalding, is that "there
are a plethora of new carriers vying to deliver services to bandwidth-hungry customers."
Spalding is CE Unterberg Towbin's broadband communications analyst. This area caught his eye while in a
previous role as a buy-side analyst covering the telecommunications industry for Soundview Asset
Management, a hedge fund. The companies he follows now range from those that focus on technology for the
so-called "last mile" of the telecommunications network to those that make the equipment to test, monitor and
interconnect fiber-optic networks.
It seems fitting that MSN MoneyCentral spoke with the analyst via his cellular phone while he was on the
streets of San Francisco. He came up with several names that already have hit home runs for their investors
and a few that have yet to score.
Can you give us a bird's eye view of the broadband communications space?
Sure. The problem that I'm focusing on is the last mile. And just to give you some background, there are really
two basic sections of a telecommunications network. There's the backbone, which is otherwise known as the
long-distance portion, and then there's the local portion that goes from the backbone to the customer. That's
called the "last mile." We've seen significant upgrades to the backbone of the network, but in terms of providing
increased bandwidth through the last mile, you've got to upgrade the local area connection. There are several
ways of solving the last-mile problem, and that's what I focus on. One way is through wireless technology,
which functions in the MMDS and the LMDS band.
Define those abbreviations for us.
MMDS is Metropolitan Multiple Distribution Service. LMDS is Local Multi-point Distribution Service. They refer
to different spectrums in the radio frequency band that have been allocated for two-way transfer of voice, video
and data.
The 'last mile' problem
What are the other ways to solve the last-mile problem?
You can also use the traditional telephone network through DSL (digital subscriber line) technology, which
basically takes the existing copper infrastructure that you use for your normal phone conversations and
upgrades it to a digital network, thereby allowing for a significant increase. We're talking hundreds or tens of
hundreds times more bandwidth.
The third way that people are solving the last-mile problem is with cable technology -- essentially using the
cable that brings you your TV service to transmit data. To provide two-way services, you have to upgrade cable
from a one-way broadcast network to a two-way interactive network. That requires the addition of fiber optics
and also two-way transmitters into the cable network.
So there's really three different ways of solving that last-mile problem. The telephone deregulation act of 1996 is
what's driving the competition among providers of those different services. So now pretty much anybody,
including the utility companies, are allowed to provide telecommunication services to the customer.
It sounds like a real horse race here. How do you handicap the three different approaches? Will DSL,
cable or wireless be the big winner?
No one player will dominate the market. DSL is more suited to the business marketplace, since office buildings
are not typically wired with coaxial cable. Cable has a higher capacity than DSL, allowing for bundled services
to be offered -- voice, video and data over one pipe. This will be very compelling to the consumer and I think
cable will surface as the dominant means of broadband access to the residential marketplace. Wireless will be
a great tool for those who don't have access to copper loops or coaxial cable.
Let's talk a little more about the key trends investors should be watching in each of these areas. How
about cable, for openers?
One of the most exciting things I'm seeing is the transition of the cable network into a full-service
telecommunications network. That really means a rebuilding of what we have known as the cable-guy type
network, where you'd have fuzzy cable and that's all you could expect. Now what's happening is that people are
putting much more reliable, telco-quality equipment into that network and really transforming it. The capacity of
the coaxial cable is so much greater than that of your telephone wire that you're going to see an explosion of
new service offerings.
What about the potential problem of having too many subscribers in one area? That slows down
bandwidth.
One of the issues with the cable network is that it's shared, so as you add more users, each user has to share
a certain amount of bandwidth with the group. So Excite@Home (ATHM) in the beginning had some issues in
terms of promising a lot of bandwidth and then not being able to deliver. But they've solved those issues in the
short term by limiting the amount of bandwidth each person may use. Longer term, AT&T (T) is making
aggressive moves to segment its network, thereby providing significantly more bandwidth to smaller groups of
people. This is one of the drivers of the companies that I cover. ANTEC (ANTC), Harmonic (HLIT) and JDS
Uniphase (JDSU) stand to prosper based on this type of upgrade.
What -- and whom -- should we be watching in the wireless end of the business?
I think Adaptive Broadband (ADAP) is a very strong story in the broadband wireless space. They have an
excellent product which allows for the delivery of voice, video and data in an extremely cost-effective manner.
The product is very small and easy to deploy relative to competing solutions, and I expect that the size of the
market their product serves is in the $4 billion to $6 billion range over the next five years.
Who's leading the field in DSL right now?
Copper Mountain Networks (CMTN) and Alcatel (ALA) are seeing strong momentum from the infrastructure
standpoint. Redback Networks (RBAK) is also a very strong player in this space.
Infrastructure
spending is so
strong across the
board that the
Sprint/MCI chaos
will have minimal,
if any, effect on the
space.
Merger impact
There have been a lot of mergers and acquisitions in this space. How much more do we have to go?
It's pretty much a steady state in terms of the equipment vendors. There are always the phenomena where the
bigger fish will buy the small fish with excellent products, and I think you're going to see that on an ongoing
basis. I don't feel that there is any particular merger frenzy happening right now in the equipment space. In the
cable services space, most of the consolidation has taken place and I don't think they'll see a lot more there.
We've just had the announcement of the biggest merger yet: MCI WorldCom (WCOM) and Sprint
(FON). What will that marriage mean to your world?
In the short term, there will be a delay in the more aggressive strategic initiatives that both of these companies
have been planning. For example, Sprint's (FON) ION network which was intended to start rolling out in Q1
2000, will most probably be delayed at least one quarter. Longer term, spending patterns should come back to
normal levels. For companies in the infrastructure space that currently derive a large portion of revenue from the
two companies, such as CIENA (CIEN), this could mean lower-than-expected revenues in the near term.
Overall, however, infrastructure spending is so strong across the board that the Sprint/MCI chaos will have
minimal, if any, effect on the space.
Given all the potentially exciting plays in the space that you cover, how do you try to pick the
companies that are going to outperform their peers?
Each stock has specific story. But what I like to look at is a company that has best-of-breed technology. You
find that by talking to a lot of customers, figuring out what kind of solutions they're looking for, and then looking
for companies that offer those solutions. Also, management is very important. In order to have sustained
success, you need to have a management team that's able to handle growth and have a technological vision of
where the company's going.
Broadband 'buys'
What stocks in your group do you currently rate as "buys"?
I've got a "strong buy" on JDS Uniphase. I think it's really a long-term success story. They are the leaders in
providing the optical components that go into building fiber-optic transport equipment, which I've seen
proliferating first into the backbone, now the metropolitan and, eventually, the local areas. They are really the
Intel (INTC) of the optics world.
What is the fundamental story here?
Basically, these folks have 20% of the net market share and very strong cash flow. They have $1 billion in the
bank and they're growing at 45% to 50% annually with excellent visibility. The numbers there are very strong.
They have consistently surprised the Street in terms of expectations. Based on the current demand, the outlook
for the optics space continues to improve.
Do you have a target price on the stock?
I do not have a target price on JDS Uniphase, but I do for most of the others that I follow.
What else should we be buying?
I like Adaptive Broadband. They have the strongest product offering in the broadband wireless space. Basically,
they have the low-cost product that can send voice, video and data to the last mile. And I think the order activity
is extremely high. Over the next six months, they've got a huge opportunity with MCI and Sprint in providing
equipment for the last-mile wireless rollout they're planning.
What are the numbers on ADAP?
They have a core business of satellite and television broadcast products. It's growing about 20% to 25% a year.
And with that growth, you're going to see 20 cents in earnings for fiscal 2000, which ends next June. But I
foresee significant upside for its broadband wireless AB-Access product, which could drive earnings anywhere
to double or triple that. If you annualize that, you have quite an attractive multiple.
Another stock that I think is very interesting is Harmonic. They're a provider of optical transport equipment for
the cable infrastructure. They have a leading position in terms of providing the next-generation optical equipment
that's needed for AT&T's networking. I don't have a target price on this stock because there's so much leverage
in their model that next year's numbers could be anywhere from my current estimate of $1.15 to $1.50.
We'll take one more.
Another stock that I'd like to mention is Digital Lightwave (DIGL). I don't officially cover the company, but they
are an up-and-coming leader in the optical test equipment space. They've got an excellent product line and it's
an underfollowed stock. They're seeing very good order strength in their core product lines, which are portable
testing products for optical networks. And going forward they've got some OEM relationships with the big optical
transport vendors like Lucent (LU), which should give them added benefits longer term. This year, they're going
to lose some money and then next year I've got them earning 33 cents. The stock is trading at about $7.50 with
accelerating growth. Very strong story there. It's quite attractive.
Stocks to avoid
Any names we should be avoiding right now?
I would avoid companies that don't have a strong, fundamental base business. A lot of stocks out there are
banking on a single product, and the success of that product alone, and there's really no protection if
expectations for the products don't come to bear. So if, for example, there's a company like Adaptive
Broadband that has a broadband wireless access product but doesn't have a business to support them if the
product doesn't take off, I'd stay away.
Are you saying that Adaptive Broadband is particularly risky?
Adaptive is a risky play, but I am highly confident that they have the right product line and management in place
to execute on the tremendous opportunity in front of them.
Anything in the space look particularly cheap?
ANTEC is a good value here. They have a very broad array of products and strength in all their product lines.
They're selling under 30 times next year's forecasted earnings. ADC Telecom (ADCT) is another great value. It's
a very good play in the last-mile space. It's selling at a discount to its peer group, which includes ANTEC,
Lucent, Nortel (NT), Adaptive Broadband and Paradyne (PDYN). That's because they don't have any one
particular product that people are excited about. But their business is growing 25% to 30% and they have
accelerating earnings growth.
Your sector has been up anywhere from 70% to 100% this year. Is it still time to buy?
The stocks have been quite strong in my space, especially in the cable infrastructure. There's been much more
visibility there based on AT&T's continued, aggressive rollout. And I think that you're going to see a continuation
of strength until the cycle ends for cable spending. But I think it will be another six months to a year before you
see a slowdown.
Do you think we'll have a market that will continue to support that type of growth?
Well, I can't really comment on how the market is going to act as a whole. There are tons of issues outside of
my expertise that might affect it. And, certainly, if market conditions are negative, I think that the valuations of
these stocks will also come down.
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