Clippings from the Goldman Sachs report, Optics: Europe/UK, June 7, 2000:
Demand exceeds supply in submarine systems and components
Within the global transmission market the submarine portion, where there is currently not enough capacity, is likely to see some of the strongest growth. The optical components market, which is also growing very strongly (some segments at over 70% per year), is currently facing severe capacity constraints. New entrants and new technologies will offer some relief from the constraints, but the market should remain strong as demand will consistently outpace supply.
Optical components businesses within systems suppliers not fully valued
Systems suppliers with components businesses will, in our view, seek ways in which to crystallize the value of these businesses in the future.
. . .
[Debunking the notion that there could be a bandwidth glut, Goldman Sachs analysts say the party will continue.]
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* The principal current problem is lack of capacity. Our discussions with industry players suggests that in several key areas, particularly optical components and submarine systems, shortages are occurring and will continue to do so.
* Installed fiber is not equivalent to usable bandwidth. It is very important not to confuse fiber in the ground with actual broadband capacity, an argument made very cogently by RHK at the conference. A lot of the fiber currently in the ground is either not useful (it is in the wrong place, it is old, etc.) or it is dark fiber, ie.e., it is not turned on. In order to light the fiber, operators need to install the relevant optics equipment (SDH, Sonet, DWDM, etc.). This, in turn, will increase demand for optics equipment.
* Growth in network traffic is exploding. Moreover, almost all of the future growth will be in packet traffic which requires excess bandwidth to function properly.
* We are not claiming that the optics market will continue to see the same huge levels of growth as we have experienced to date. We are claiming, however, that the market should, at the very least, see strong, sustainable growth over the next few years. The market research firm RHk, for its part, is forecasting that the total market should reach $90bn in 2003. Indeed, we think it is safe to say that the underlying concensus of all speakers was that the optics market, even after a year of record growth in 1999, should continue to see strong growth over the next few years.
The future of optics
To try to pin down a little more precisely the future direction of the optics market, we posted a series of questions at the beginning of our conference, which we review in this report. Our hope was that by the end of the conference we would be able to at least partially answer some of these questions. In the end we did a little better than expected and we believe we got answers to most of the questions. These we summarize in Exhibit 1 and detail in the following pages. There is, of course, a lot that remains the subject of debate, and we emphasize that the following discussion is our take on the conference.
Q: Will increasing DWDM deployment lead to bandwidth oversupply down the road?
A: No, because of capacity shortages and exploding demand
Q: What is the outlook for metro-DWDM?
A: Prospects are positive, but size and timing of growth uncertain
Q: How quickly are we moving towards IP over DWDM?
A: Not as quickly as many may think
Q: What is the future for ATM, SDH and SONEt in an IP/DWDM environment?
A: These older technologies should continue to see good growth for the short to medium term at least
Q: How will customer demand for end-to-end solutions impact the optics sector?
A: The big boys face real competition from smaller suppliers
Q: What is the likely impact of system-in-a-box?
A: Devices combining optical and data networking are coming to the market, and both large and small companies will have room
Q: What is the benefit of shortening lead times?
A: Missing a cycle or having the wrong product available can erode market share and revenues; but recovery can be quick
Q: What is the impact of current shortages in components and how long will it last?
A: Shortages are slowing network build and spurring new technologies; demand to outstrip supply for some time to come
Q: How will component suppliers move up the value chain?
A: By developing a broader range of technologies and manufacturing know-how
Q: What are the prospects for further consolidation in the components industry?
A: More consolidation is in store, and possible partial flotations of optics businesses
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Each answer is expanded within the report. A few nuggets:
* Optical components market to reach over $30bn in 2004
* Submarine systems are also likely to be a bottleneck in the future. Supply in this market is constrained both by the small number of qualified suppliers of the complex systems and the relatively slow speed at which they can actually build the networks. Traditionally, when investors and analysts talk about DWDM, they mean the terrestrial DWDM market, the great majority of which is located in the US. But the submarine systems market, which was worth $5bn in 1999, is mostly composed of DWDM. Both markets are forecast to grow at roughly the same rate (around 45%) over the next few years. In other words, although terrestrial DWDM has been grabbing headlines of late, the potential for submarine systems is just as great and those suppliers with large market shares in submarine DWDM should be very well positioned for the future. Alcatel is the leading supplier of submarine systems with Tyco a close second. But indications from the Flag presentation are that Tyco is easing itself out of this market as it focuses more and more on building submarine systems for its own use. This leaves Alcatel as the clear, dominant independent supplier of submarine systems worldwide.
* Second, we agree with RHK's view that "fiber in the ground does not equal bandwidth in the network."We should be concentrating on operating capacity, or the amount of fiber that is actually turned on and in use. That is because a lot of the fiber currently in the ground is either not useful. . . or it si dark fiber, i.e., not turned on. In order to light the fiber, operators need to install the relevant optics equipment (SDH, Sonet, DWDM, etc.). This, in turn, will increase demand for optics equipment.
* Third, and perhaps most importantly, we believe that the amount of traffic flowing across the globe's networks is about to explode. The latest RHK forecast. . . suggests that in four years time, the total amount of network traffic is about to increase by 30 times. Moreover, almost all of the future growth will be in packet traffic which requires excess bandwidth to function properly. This is because packet traffic generally requires the excess capacity to assure adequate reliability. And, network utilization will favor using bandwidth less efficiently as a trade-off to improve flexibility and network manageability.
* RHK is forecasting the metro/IOF (inter-office) DWDM market will be at $1.1bn in 2003, growing from a little over $100mm in 1999. But this figure could shift dramatically if the rollout DWDM systems in the metro area is accelerated or delayed. other forecasts in the market range from a few hundred million dollars to $2bn during this same time period.
* We are firm believers in the prospects for IP as a unifying communications protocol, but the conference participants led us to the conclusion that it may take longer than expected. The full management, quality of service and restoration capabilities of SONET/SDH and ATM are not yet available in an IP over DWDM architecture, so some of these more mature technologies will still have to be used even in the most advanced networks of today and the near future. . .
* Shortening lead-times combined with very tight supply channels means that systems suppliers will have to manage their product rollout schedules and sub-supplier relationships very closely or face short-term fianancial shortfalls (read profits warnings). As product life cycles move from years to months, missing a cycle or having the wrong product available can cause massive changes in market position and resulting losses in revenues. One of the latest examples of this is Lucent's profits warning at the beginning of this year. Although there were many factors which contributed to it, one was that Lucent had not rolled out an 80 channel DWDM system in time, as it had expected demand on the lower channel count systems to remain strong. Because of this, Nortel has been able to extend its lead in the DWDM market. meanwhile, Lucent's stock price is 18% below its opening price this year and Nortel's is up 16% since the beginning of the year.
The flip side of all of this is that companies which miss one product cycle can, if they are fast enough and determined enough, get back in for the next product cycle.
*. . . even if current production levels can be significantly increased, we believe demand will probably still outstrip supply for some time to come. That is because we believe network build-outs and additional capacity will lead to increased demand from end-users for bandwidth. And, the demand for bandwidth will lead to additional network build-outs . . . [a] "virtuous bandwidth circle" of bandwidth leading to demand leading to more bandwidth. . .
* We believe there will be more consolidation in the industry, as a large number of start-up optical components companies become acquisition targets for the established optical components companies. Very often, these start-ups may have little or no revenues but they will have very good next-generation component or manufacturing technology which the larger suppliers are eager to acquire.
Given that the market is now putting higher values on optical components companies, as a result of the tremendous growth in the sector, we believe many systems suppliers are taking a second look at their own components businesses and considering ways in which to crystallize the value of these units. Although we think full divestments are unlikely, though not impossible, we believe partial listings are a very real possibility, opening the door for investors to gain additional exposure to this high growth sector. Of the large systems suppliers, Alcatel, Lucent and Nortel have significant optical components businesses. Marconi has a small optical components business and is specifically developing a tunable laser which could be well received by the market. |
