Could fiber optics be a mirage?
Are investors returning to their wild speculative trading days of old in the IPO market? It certainly seems that way, judging by the huge pops and lofty valuations that companies in the fiber-optic sector have recorded as of late.
On Friday, Corvis (Nasdaq: CORV) and Avici Systems (Nasdaq: AVCI) recorded massive opening-day gains. Corvis, which priced at $36 per share, opened at $95, and finished the day at $84.72, a 134 percent increase. And Avici did even better. It priced at $31, opened at $93.31, and continued to climb, finishing the day at $96.75, a 212 percent one-day gain.
Both Corvis and Avici sensed the enthusiasm and growing demand for the fiber-optics sector and repriced their offerings earlier in the week. Corvis originally priced its 27.5 million-share offering at a range of $13 to $15 per share, but revised it midweek to $28 to $30 and then raised the size of the offering to 31.625 million shares. Avici had followed a similar aggressive pricing strategy, raising its offering price from between $18 and $20 to between $28 and $30, and increasing its offering size from 6 million to 7 million shares.
The anticipation for these two offerings was so great that it even prompted one analyst to initiate coverage of the stocks before either started trading. Gina Sockolow, an analyst with Bream Murray, a small New York-based brokerage, rated Corvis a Buy and Avici a Hold on Friday morning.
While it is important for analysts to separate themselves from the pack, this seems a bit extreme even for the red-hot fiber-optic sector. Ms. Sockolow could not be reached for comment. Usually the first research reports about a newly public stock come from analysts whose firms are involved with underwriting the deal; these analysts must wait 25 days before initiating coverage. Bream Murray was not an underwriter for either deal.
BELIEVE THE HYPE
The huge premium left many investors, especially those who could not get in at the IPO price, wondering if these valuations were justified. Can the fiber-optic companies live up to all this attention and soaring valuations, or is it just Wall Street's latest Cinderella?
"The demand for fiber optics is not a passing fad," said Todd Koffman, an analyst with Raymond James in St. Petersburg, Florida. "The companies in this sector are shipping real products for real revenue -- the growth in this area is staggering."
According to estimates from Mr. Koffman, the demand in the fiber-optics sector is so great that production is expected to increase by three- to four-fold over the next 18 months. He said this is a growth rate that cannot be found in any other industry in the market.
Mr. Koffman admits that the valuations that these companies are receiving today may seem lofty, but with this huge demand as a backdrop, these valuations will be deserved in the coming months when the revenue starts flowing in from the customers.
So the real question is not whether the customers need the products; it is whether the fiber-optic companies can supply the products fast enough to meet this mounting demand, said Mr. Koffman.
The demand has already outpaced the supply, which was one of the key factors that led JDS Uniphase (Nasdaq: JDSU) to buy SDL (Nasdaq: SDLI) this month for $41 billion. Simply put, SDL had the parts and the production capabilities that JDS needed. The current excitement among investors surrounding the sector was no doubt fueled by this deal. SDL was a little-known company among investors before the deal, but the stock has increased more than 30 percent in the three weeks since the deal was announced.
With that in mind, expect more optical IPOs down the road. To that end, MRV Communications, an optical incubator, filed for an IPO for its optical components unit, Luminent, on Wednesday. And on Thursday, French networking company Alcatel announced that it would set up a tracking stock for its optical component business.
IPOS VS. THE AFTERMARKET
Clearly the excitement surrounding the IPOs from Corvis and Avici is feeding the aftermarket for these and other companies in the sector. According to Kevin Slocum, an analyst with Wit Soundview, the four fiber-optic IPOs that came to market in the first half of 2000 have averaged a first-day gain of 241 percent. These four companies remained strong after their initial offerings and went on to average a return of 414 percent in the first month following the IPO.
The strongest of the four remains New Focus (Nasdaq: NUFO), which is trading up more than 350 percent over its IPO that was priced at $20 in May, although New Focus tumbled more than 40 percent this week after the company announced it would be selling 3.5 million shares in a secondary offering.
Mr. Slocum expects the optical IPOs to do well at least through the second half of the year. After that, investors will be looking to see if companies can execute -- and that is the real unknown and source of risk that investors need to be aware of today. Corvis, after all, has no revenue yet, just a highly regarded technology.
The market is clearly mixed over whether the fiber-optic companies can sustain these valuation levels, but investors seem content for now to just ride the wave.
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