A portfolio full o’ goodness
Fibre stocks are darn expensive. But we’ve found some that will get your money moving
By Kevin Libin, Peter Verburg and Andrew Wahl | Sept. 18, 2000
If the record-breaking performance of the Toronto Stock Exchange 300 index this summer has taught investors anything, it’s that fibre is where the action is. Nortel Networks Corp. (TSE: NT) has grown so large since it adopted a fibre optic strategy about three years ago that its $350-billion market capitalization now makes up more than one-third of the index. Then there are the dream stocks of the past year: optical components maker JDS Uniphase Corp. (TSE: JDU) is up more than 350%, while fibre optics manufacturer C-MAC Industries Inc. (TSE: CMS) of Montreal has gained more than 500%. And those are just the Canadian stocks. Look beyond our borders and the list of big winners grows as long as the fibre lines they build and bury.
If you’ve missed out on the brand names, you haven’t lost your chance to make a bundle. RHK Inc., a San Francisco-based telecommunications research firm, predicts the optical transport market will grow to almost US$90 billion by 2003–roughly three times what it was last year. "I’m bullish on the entire industry," says Rob Millham, an analyst with Research Capital Corp. in Vancouver. "I think that’s a no-brainer."
What’s more of a brainteaser is deciding just how to tap into this stream of gold. You can’t ignore a fibre giant like Nortel Networks or its main rivals, Cisco Systems Inc. (Nasdaq: CSCO) and Lucent Technologies Inc. (NYSE: LU), but there’s much more out there–including many stocks that may not be quite so richly valued. From companies that make the fibre itself, to those that put it in the ground or under the sea–and even the guys who sheathe the strands in protective plastic–there are plenty of ways to play the fibre market. "It’s a big industry," says Brian Van Steen, an optical networking analyst in Toronto with RHK. "There’s always room for companies to enter a niche part of the market."
But although there are many ways for you to get your fibre, none of them is particularly cheap. "The rising tide has lifted almost all of these ships," says Alex Benik, a fibre optics analyst with the Yankee Group, a Boston-based research firm. Millham agrees: "The whole fibre area is feeling a lot like the Internet back in February and March–it’s super hot. And in some situations, I think it’s a challenge to justify the market caps."
Some analysts claim it’s too early to spot the winners–every company seems to be going gangbusters. We suggest you spread your risk by investing broadly in the industry and picking the best company within each segment. An informed investor can’t lose: after all, fibre is good for you.
Bookham Technology PLC
Nasdaq: BKHM
If you’re looking for the next JDS Uniphase, you might want to start with a company that is in the same business. You may have heard about Bookham already. It’s been in the news recently as rumors circulated that Warren Buffett might buy a stake. It has also been pegged as the next takeover target for shopping addict Nortel Networks.
Like JDS, Bookham manufactures the optical components that make and direct the light signals that travel through fibre optics networks. Bookham makes both active systems, which use electricity to shoot light down the fibre, and passive systems, which require no electricity. Emerging technologies for passive components could be the next craze in fibre optics.
Both companies are increasing their revenue at a phenomenal pace, though Bookham, with US$14.5 million in sales in the first six months of 2000, is still about 160 times smaller than JDS by market cap. "Bookham trades on a pretty hefty valuation and the company has very little revenue, but it certainly has the potential to grow that very rapidly," says HSBC Securities (Canada) Inc. analyst Harshad Thanki. "It has a number of patents on the processes it’s been working on over a number of years." Whether that research will convert itself into dollars is a tough call. But consider this: Bookham is in a market where there is a large backlog of orders. That alone should make it a decent long-term play.
Williams Communications Group Inc.
NYSE: WCG
All the high-tech wizards making fibre optics components would be nowhere if it weren’t for a few companies willing to get their hands dirty. Somebody has got to grab a shovel and start burying some fibre underground in order for all these systems to work.
Companies like 360networks Inc. (TSE: TSX), Qwest Communications International Inc. (NYSE: Q) and Global Crossing Ltd. (Nasdaq: GBLX) are racing to see who can lay the most fibre, in the best locations, and do it faster than the rest. But before they can even start, they first have to obtain the necessary rights of way. That means finding a route and negotiating with hundreds of landowners (usually big railroad or utility companies), all the while making sure they don’t mess with any sewer systems or gas pipelines along the way. "Rights of way can be quite hard to come by," says HSBC’s Harshad Thanki.
Williams Communications Group Inc. has the enviable advantage of ignoring all those headaches. That’s because it’s on such good terms with the owner of a lot of those pipelines–its parent, Williams Cos. Inc. (NYSE: WMB) is an enormous energy company that boasts an extensive gas pipeline network in North America. In 1985, it established Williams Communications (of which it still owns 85%) to run fibre right next to the gas pipelines.
Last October, the parent company took Williams Communications public at US$23 per share. In March the shares peaked at US$61 and have spent the last six months sliding to the US$28 level. That means you can pick it up for about six times its sales–much cheaper than 360networks, which is trading at close to 15 times revenue.
With pipelines in two countries, Williams could emerge as a leader. "They have an advantage because they’re up and running, they’re out of the construction phase," says the Yankee Group’s Alex Benik. "They already have it in the ground, so it’s not a matter of execution. It’s already there."
Total Telcom Inc.
CDNX: TTZ
The big companies running fibre optic cable between major cities couldn’t care less about remote, thinly populated communities such as Dawson Creek, BC, and Grande Prairie, Alta. That suits Total Telcom Inc. just fine. The Edmonton-based fibre optics network builder has found a niche hooking up so-called tier two markets. "Our goal is to provide access to [remote] towns for any service provider that wants to enter the market," says CEO Craig Baker.
Total Telcom has been around since 1986. It began life as a small construction company, installing fibre optic cables for telcos in Canada and the US. But with demand for new fibre exploding, the company decided last year to build and operate its own networks. Its first project is a 24-strand fibre optic line from Edmonton to Fort St. John in northern BC, with drop-offs in all the small towns and cities along the way. Much of the $12-million cost will be covered by preselling capacity to rural cable companies and wireless operators that are unable to buy capacity from Telus Corp., the incumbent phone company. Baker says eight of the 24 strands have been spoken for, and a number of telcos have expressed interest in the remainder. Total Telcom plans to keep four strands for itself.
The company is growing fast. Its revenue climbed from $4.5 million in the last fiscal year to an estimated $17 million this year. Baker hopes to hit $100 million by 2003. The company will soon be moving from its cramped facility in northeast Edmonton to a nearby building that’s three times bigger. Total Telcom’s stock has had a wild ride in the past year, reaching a high of $4.90, before plunging in the spring sell-off. It was recently trading in the $1.35 range, which looks cheap. The company has almost no debt and $12 million in equity, leaving it ample ability to borrow.
The breathing room will come in handy as Total Telcom plans other networks around Alberta and BC. It’s also looking at secondary markets in the northwestern US and Ontario. Baker says remote towns are very receptive to his company because a new fibre link means they’ll get improved services. "People get excited when we arrive," he says. "In Dawson Creek we hit the front page of the local paper."
Ciena Corp.
Nasdaq: CIEN
You don’t have to look hard to find a newly hatched optical networking company that bills itself as the next young star. Start-ups like ONI Systems Corp. (Nasdaq: ONIS), Corvis Corp. (Nasdaq: CORV) and Sycamore Networks Inc. (Nasdaq: SCMR) would like you to believe they are primed to become the next Cisco Systems. But you’re probably better off investing in a company that’s been around for a while–like Ciena Corp.
Unlike, say, ONI, which has been making optical equipment for less than three years, Ciena’s been in the business since 1992. And though Ciena doesn’t play in the same league as the likes of Lucent Technologies, the stock market does seem to be paying attention. "There are a lot of players that are hoping to be like Ciena, which started out small and grew into a very large player and has never been acquired," says Neil Dunay, a senior analyst at KMI Corp. in Newport, RI. "Since they came into the market, there haven’t been as many big success stories."
That’s putting it lightly. Ciena shares are trading at more than US$200, or 500 times earnings. And, yes, we admit that’s a whole lot of money to pay for a stock. But the days of bargain hunting for optical networking companies are long gone. And at least Ciena is profitable–it made almost US$500 million last year. "You have companies like Corvis, which has essentially no revenue and a US$30-billion market cap, which is fairly staggering," says Yankee Group fibre optics analyst Alex Benik. "Though Ciena and Sycamore have more revenue [than Corvis], Ciena has much more revenue. And they’re all valued fairly comparably."
If you think of it that way, Ciena might be undervalued relative to its competitors. "It has a track record and a breadth of customers that Corvis and Sycamore just don’t have," says Benik. "Companies like ONI, Corvis and Sycamore are really dependent on a very short list of customers." Of course, you’ll pay through the nose for Ciena. But that’s only because it’s one of a kind.
C-MAC Industries Inc.
TSE: CMS
Pay close attention to the evolution of any new technology and you’ll notice the same pattern repeating itself. Manufacturing pioneers start out making every little nut and bolt themselves, but in order to enjoy economies of scale, they eventually move to outsourcing as much as they can. And if you’ve been watching C-MAC Industries, you know that trend has already begun in the optical business. "IBM used to make everything," says Harshad Thanki, an analyst with HSBC Securities Canada, "the box that the computer sat in, the components, the disk drives, the memory, the screens, you name it. Now nobody in his right mind would go and make all the parts for a computer. Clearly in the long term, that’s what is going to be happening with network equipment."
That’s why C-MAC shares have been on such a tear over the past year. The Montreal-based manufacturer has entrenched itself as a key supplier of optical components to Nortel Networks. As it chalked up record sales last year of $1.2 billion, its share price surged from less than $18 last fall to $110. Now, with the expectation that Lucent Technologies will join the trend toward outsourcing, there’s good reason to believe that number will continue to rise and that C-MAC’s best growth years are still to come.
Even with shares trading at about 100 times earnings, investors should be skeptical of claims that the stock is too expensive. "Overvalued is really a difficult term," says Thanki. "People are pricing in a lot of growth, which companies like C-MAC have shown they can deliver. [Outsourcing manufacturers] can grow their revenue at phenomenal rates, and more importantly, they can sometimes grow their earnings faster."
And while Flextronics International Ltd. (Nasdaq: FLEX) and Toronto-based Celestica Inc. (TSE: CLS) are both publicly traded heavyweights in the component outsourcing business, if you look closely, you might find that C-MAC has some enviable advantages. "They have very large exposure to Nortel’s optical side, but the wireless side of Nortel is interesting, and an estimated 10% to 14% of every dollar of Nortel wireless sales may end up going to C-MAC as well," says Bob McWhirter, vice-president and portfolio manager with Triax Management, which is also starting a new Canadian high-tech mutual fund. "They’ve also recently raised $1.1 billion and the speculation is that they may end up acquiring Lucent’s electromechanical division, which is vaguely similar to the one they acquired from Nortel, and is approximately 60% the size."
Imperial PlasTech Inc.
TSE: IPQ
If all this talk about lasers and switches makes you yearn for the simpler, old economy producers of steel and lumber, this one’s for you. You see, that precious fibre optic cable network needs to be protected from the elements somehow. That’s where Imperial PlasTech Inc. comes in. It’s the low-tech company that supplies the plastic pipes to cover high-tech fibres owned by the likes of 360networks and Williams Communications. Hey, it’s not very glamorous work, but someone’s got to do it.
And that could be why Imperial PlasTech shares have been so popular lately. The stock price jumped from just above 50¢ in March to $3.45– and it still trades at just 23 times earnings. You won’t find bargain-basement multiples like that in Silcon Valley. Of course, Imperial PlasTech’s success could have something to do with the Toronto-based company’s financial performance–earnings tripled in the span of a year, from $500,000 in 1998 to $1.5 million in 1999. And if you need another reason to take a look, consider this: Imperial PlasTech is a good hedge. If things ever get ugly in the optics business, it can always fall back on making pipes for hockey rinks and sewage systems.
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