As if we needed more evidence of the strength in this sector, here are some notes on fiber optics components by JPMorgan's Charles Willhoit, dated June 1, 2000. (could explain last week's strength)
Life on the Inside . . .
In this rather volatile stock market, we think it's important to address the ultimate pressing issue in the optical components market. When do supply and demand come into balance? It's very well known that optical components are in great demand today and that supply, at best, is limited. Why? Because service providers realized a couple of years ago that using light (photons) to transmit massive amounts of information is the way to a cheaper, faster, more profitable, long-term network build. The problem was that the communications equipment industry wasn?t ready for this demand. Until very recently, all we did with light was send voice signals across fiber, a relatively simple task given that voice takes up little bandwidth, and fiber provides a ton of bandwidth. As data and Internet traffic began to fill up these networks, DWDM technology became commercially available, and all of a sudden fibers that were carrying one signal at a time were able to carry 8, 16, 40, and now 80 channels simultaneously.
While certainly this creates huge economies of scale for service providers (being able to shove much more information onto their networks), this has put immense pressure on the optical equipment and components companies to keep pace. Why? Because optical components with high-power levels, precise wavelengths, low dispersion, high modulation, etc., that are required to meet the demands of today's optical networks, are new technologies, they are typically very hard to manufacture in high volumes. And it isn't getting any easier. . .
First the conclusion. We think that the supply/demand imbalance for optical componentswill remain for some time to come (two to three years or more), and we have several reasons to justify our answers.
1. As demand for higher channel counts, speeds, and distances continues to increase in optical networks, the number of components needed inside of optical networking boxes rises dramatically. It's easy for us in the investment world to talk about moving from 16 to 40 to 80 to 160 channels at OC-48 then OC-192 then OC-768, but the reality is that moving up these scales, especially in high volumes, is an extremely difficult task for optical components suppliers. If you think we are capacity constrained today in a world where most of the volume is still coming from 40-channel systems at OC-48, wait until we move to 160 channels at OC-192. This will require four times the number of source lasers, modulators, pump power, and filtering capabilities. And all of these components are next generation products that are even harder to manufacture in volume. A couple of interesting points. First, an 80-channel, OC-192 DWDM system today requires roughly 100 source lasers and 100 modulators (80 specified to particular wavelengths plus 20 to spare). Prices for source lasers today run around $1,000 a piece, and OC-192 modulators are about $4,000 each. This means that just the source lasers and modulators will cost an equipment company $500,000 for one DWDM terminal. By the way, there are really only three companies in the world that can produce OC-192 modulators in any meaningful volumes. Now imagine moving to 160 channels at even higher speeds. This is not trivial stuff.
2. Incumbent systems providers are looking to outsource more and more components and new systems players that outsource 100% of their optical components are just beginning to get some traction. Merchant optical components suppliers are being bombarded with demand from all sides. From the top are moves to higher speeds, channels, etc. From the right are incumbent systems suppliers like Nortel and Lucent looking to outsource more and more components as the shift to a more software-centric business model is underway. From the left are new systems providers such as Sycamore, ONI, and even Cisco that are already outsourcing nearly 100% of their components and that are beginning to win some contracts with carriers. The moral here is that the supply/demand imbalance for the merchant optical components suppliers may actually being getting worse as new players and new technologies seem to be outweighing even the aggressive capacity buildouts taking place. |
