<<Industry Analysis
Feb 16, 2000
Internet: INTERNET SERIES: Fiber Optics
Senior Analyst: Luciano Siracusano (2/16/00)
Fourth of a 15-part series.>>
.
.
.
<<Not surprisingly, the fiber optic merchants that make the components and sub-systems for these larger optical networkers
have become the darlings of Wall Street. As you can see from the chart below, these “merchant vendors” saw spectacular action in
their stocks last year, with the average return surpassing 1000% …that's right, the average stock in the group was a 10-bagger in
1999.
Company Ticker Market Cap. ($Bill.) Price 2/14/00 1999 % Change YTD % Change
JDS Uniphase JDSU $72.1 $202.44 3932.80% -25.49%
Corning GLW 46.4 180 189.75 39.60
Etek-Dyanamics ETEK 13.5 199 403.27 -47.82
SDL Inc. SDLI 11.9 338 1000.31 55.05
Harmonic Inc. HLIT 3.7 122.86 912.67 29.41
MRV Communications MRVC 2.1 79 916.16 25.64
Ortel Corp. ORTL 1.9 160.44 1271.4 33.7
NetOptix OPTX 1.8 156 1568.75 133.71
Digital Lightwave DIGL 1.7 61.63 2667.57 -3.71
Coherent, Inc. COHR 1.6 64 212.56 139.25
Methode Electronics METHA 1.5 42.41 108.19 32
Newport Corp. NEWP 1.3 144 171.36 214.75
GROUP AVERAGE GAIN/LOSS 1112.89% 52.17%
Many of the fiber optic stocks discussed below are cresting on phenomenal growth, some increasing revenue and earnings per share by more than 100% in the most recent quarter. Because of the rapid pace of consolidation in the industry, feverish speculation is also taking place, making it difficult for some investors to separate the wheat from the chaff.
In recent weeks, companies such as APA Optics (NASDAQ:ADAT) and Coherent Inc. (NASDAQ:COHR - news) have incited buying panics after issuing press releases stating they intended to enter the DWDM market.
More speculative investors have mined the SEC database for companies with “light” or “fiber” or “optics” in their names, hoping to stumble upon the next Precision Optics (NASDAQ:POCI - news) , which ran from $0.69 to $26.75 in just the past three months, or Lumenon Innovatv (NASDAQ:LUMME) , a bulletin board stock that soared from $0.75 to $48 before crashing back to earth.
Below, we will limit our discussion to only those fiber-optic suppliers which have posted profits in their most recent quarter with market caps greater than $1 billion.
Click for screen.
The clear general in the group is JDS Uniphase (NASDAQ:JDSU - news) , the industry Leviathan that was created last year with the merger of JDS Fitel and Uniphase. Since then, the company has grown through a series of completed and pending acquisitions to become the dominant supplier of fiber optic components to the makers of telecommunications and cable-TV networking equipment.
By adding Epitaxx's detector and receiver products, Optical Coating Laboratories' optical filters and (soon to be acquired) E-Tek Dynamics (NASDAQ:ETEK - news) packaging capabilities to its own portfolio of passive and active components, JDS Uniphase has reconfigured the industry in its own image. Amazingly, this $70 billion colossus is expected to grow cash earnings by at least 80% in the coming year, as it increases capacity two to three times to meet the burgeoning demand.
Although both Nortel and Lucent have their own “captive” component suppliers within their companies, they both depend upon JDS, as does Cisco and other upstart optical networkers. Increasingly, outsourcing is becoming a prevailing trend in the industry, as competition accelerates and greater premiums are placed on being first to market.
On Monday, Corning (NYSE:GLW - news) took a major step towards becoming an end-to-end supplier of fiber optic modules to the telecommunications market. It announced two acquisitions and the creation of a new joint venture in Asia. [joint venture in Asia,
sounds familiar <g>]
Corning believes it can marry the optical filter capabilities of its latest planned acquisition, NetOptix (NASDAQ:OPTX - news) with the automated packaging capability of its Korean partner, Samsung Electronics, to become the highest quality, lowest cost producer of DWDM components.
Corning, which is also acquiring British Telecom's (NYSE:BTY - news) Photonics Technology Research Center for approximately $66 million, now has the potential to develop next-generation modulators, amplifiers and lasers. As the company derives an ever-greater percentage of its revenue from the telecom sector (it generated more than $400 million in photonics/component sales in 1999), overall profitability will improve, making Corning a relatively inexpensive way to buy into the fiber-optic boom.
Another of JDS Uniphase's main competitors, SDL Inc. (NASDAQ:SDLI - news) , has also witnessed spectacular top- and botttom-line growth. SDL's technical proficiency in “active” components -- the devices that generate and amplify light through a network, including pump lasers -- has enabled the company to become a preferred supplier to some of the world's largest subterranean carriers. [MRVC OA's main focus is “active” components unlike many in the list like ORTL]
Going forward, SDL is expected to play a larger role in both long haul (terrestrial) markets and in the “urban loop” market, which will connect consumers and businesses within cities.
But with JDS and SDL on the tongues of virtually every growth fund manager in America, individual investors may be wise to look for the next optics play. Both companies are trading between 30 and 50 times estimated 2000 revenue. Interestingly JDS Uniphase is down more than 25% on the year, while some of the smaller players in the sector have headed higher.
So, which are the next optics plays?
Companies like Newport (NASDAQ:NEWP - news) have shown that a growing exposure to the fiber optic sector can dramatically alter the way Wall Street values your company. And Ortel (NASDAQ:ORTL - news) , which in many ways has the weakest fundamentals in the group, had enough broadband potential to lure Lucent into making a $3 billion offer to buy the company.
Another rising star that has shown it has more going for it than just a pretty name is Digital Lightwave (NASDAQ:DIGL - news) . A few weeks back, the Wall Street Journal tried to make The Lightwave the poster child for “overvalued fiber-optic stocks.”
Although fiber junkies should applaud the Journal for inducing a dip in the stock price, investors are better served by focusing on the company's top line, which grew by more than 100% in 1999 and its bottom line, which grew 44.4% on a sequential basis in the most recent quarter.
Lightwave, which tests advanced optical systems [like a Teradyne (NYSE:TER - news) for the fiber optic industry], serves the biggest players in the industry.
On Tuesday, Nortel placed a $6.4 million order with Digital Lightwave to buy its latest optical test and measurement equipment.
If cable suits your fancy, one of the better mid-cap plays around today is Harmonic (NASDAQ:HLIT - news) . Harmonic, which sells to customers like AT&T, Time Warner (NYSE:TWX - news) , Cox Communications (NYSE:COX - news) and Charter Communications (NASDAQ:CHTR - news) , reported 1999 net sales of $184.1 million ($63.3 million in the fourth quarter) and earnings of $0.76 per diluted share. This compares to a loss of $0.92 in 1998.
Harmonic designs and makes digital fiber optic systems, including optical transport solutions - primarily devices that provide a “return path” in hybrid fiber optic/coax cable lines. This technology enables information to flow in two directions over cable lines (e.g. both to and from a consumer's PC).
We expect all of these companies--JDS Uniphase, Corning, SDLI, Newport, Digital Lightwave and Harmonic--to outperform the year-ahead market.
Because of supply constraints in the industry and the rapid growth rates dictated by the massive capital spending of the larger players up the food chain, we believe the only real risk these companies face in the next 12 months revolves around execution – managing their own rapidly growing manufacturing capacity. [MRVC's OA just completed a major 3 fold plus expansion]
Over the long-term, we suspect the smaller companies in this group will likely be acquired down the line. The leaders in their respective markets will likely remain so.
The barriers to entry in the sector will grow larger as established companies forge deeper relationships with the equipment makers they supply. [MRVC OA's two biggest customers are Marconi and Cisco]
Because the components sold need to be “best in their class,” companies will not easily switch to new vendors. Given that the systems get buried beneath the ocean or stretched out across deserts, carriers will stay with suppliers who prove their technical competency in actual service. [MRVC OA's two biggest customers are Marconi and Cisco]
Both these high “switching costs” and the movement in the industry toward one-stop shopping make it unlikely that any of the new companies now coming public will ever be able to amalgamate itself into the next JDS Uniphase.
The leaders in the sector are likely to get even larger, as the advantages of becoming an end-to-end supplier become more evident.
Bottom Line:
Our favorites for the year-ahead: Corning and Harmonic. Because the ramp-up of these optical networks will take the better part of the decade, investors are advised to buy and hold for long-term gains.>>
Imbedded bracketed comments are my own. BxK
fnews.yahoo.com |
