ONIS
Metro-area optical networking systems
Fiber optic communication networks are regarded as one of the solutions to the exploding demand for communications capacity. The industry?s infrastructure is composed of 3 segments. The long distance segment delivers high speed transmissions over regional, national, and inter-continental distances. It is a point to point network, meaning it goes from one consolidated point to another. The enterprise network segment tends to be company specific and delivers information to and from individual end users. Both of these segments have been under broad development. However, there has been a missing segment, one that effectively connects the long distance network terminus point to the enterprise network?s entry point. To date it has been ineffectively addressed by ?jury rigging? long distance approaches. But that has proven to be disappointing and expensive. This remaining segment is referred to as Metro Networks.
ONI Systems pioneered the metro networking segment of optical networking. It has developed specialized equipment designed for the specific needs of this segment. It?s equipment is the first ?all optical network?, eliminating the need for photon/electron repeater and amplifier bridges so common in long distance networks. So operation is faster, cheaper, and more effective. It also provides a complete turnkey operation including service & support, service diagnostics, and even billing & control software.
Initial response has been positive and early customers include Alcatel, Ciena, Cisco, Juniper Networks, Lucent, Nortel, Siemens, Sycamore Networks, and Tellabs. The firm has also just completed an OEM deal with Lucent to supply China. However, it?s market remains very narrow. For example, 4 clients accounted for all of the 1Q?00 revenues.
The firm emerged from start-up in ?98 and between ?98 and ?99 revenues increased by 75% reaching $3 million and aided by an acquisition. In 1Q?00 revenues surged to $3.6 million suggesting a $14.5 million annual run rate. However, 1Q?00 gross margins declined to 21.6%, reflecting increased product development and price competition. Now this company is still in the early stages of it?s growth cycle. Operating, net profit, and cash flow margins are negative and will remain so in the near future. The firm is still incurring very heavy R&D expenses, more than 3 times revenue. However, for a company at this stage such investments are expected and represent intangible business development assets vs pure expenses.
Valuations in this sector have been very favorable. Ciena, Juniper Networks, and Tellabs are trading in the upper half of their 52 week trading ranges. Recent IPO?s may also add some perspective. Sycamore Networks was a $285 million deal offered on 10/22. Offered at a split adjusted $12.67, it closed at $61.58 for a 386.2% first day. It recently traded at $79.19, adding 28.6% in the aftermarket. Finisar was a $155.8 million deal offered on 11/12. Offered at a split adjusted $6.33, it closed at $28.96 for a 357.3% first day. It recently traded at $31.80, adding 9.8% in the aftermarket. Most recently, New Focus was a $100 million deal offered on 5/19/00. Offered at $20, it closed at $51 for a 155% first day. Reflecting the strong sector valuations, pre-offering demand has been reported to be very heavy (Street Scoop 5 star rating).
This is an example of the right firm in the right industry. As the pioneering all optical metro network supplier, it has a breakthrough application of technology. Such firms typically receive early valuation premiums. While still emerging, fundamentals remain weak but opportunities are rapidly developing. The recent Lucent-China deal has not yet been reflected in it?s performance. Add to this a seasoned management team and the participation of high profile investors Internet Initiative Japan, CCT Telecom, Sun Microsystems, and Williams Communications. Combined with the strong pre-offering demand, we expect a very favorable initial reception (e.g., 50+%) followed by near term volatility and long term modest appreciation.
Note: the terms of this offering have been increased by 47%, to $21-$23 from $14-$16.
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