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By: jas1 $
Reply To: None Thursday, 14 Sep 2000 at 8:42 AM EDT
Post # of 15890
A must read for all NT longs...the heart of the issue.
Subject: Fredhager.com Weekly Update 9.8.00
We have decided to add Nortel to our Elite Portfolio. We will follow up on
Monday with more details, but for now, here is our detailed report on
Nortel Networks.
Nortel Networks
Throughout the past year, a great deal of attention has been given to young
upstarts in the telecom equipment field that, in a very brief period of
time, have emerged to sport multi-billion dollar market caps. These
companies, operating out of garages and small offices only a couple of
years ago, with then-obscure names such as Redback, Sycamore, and Juniper,
now sport multi-billion dollar market caps and have their products
purchased en masse by the world's leading ISPs and carriers. However, as
phenomenal as the rapid growth of such companies may appear, it's important
for investors to remember that these companies aren't the recipients of the
lion's share of the infrastructure spending that's being done by these
carriers and ISPs. Rather, the leading beneficiaries (in terms of dollar
amounts) have been older, established tech companies that have seen demand
for products that they've been selling for many years, not to mention their
annual growth rates, skyrocket thanks to the highly frenzied pace of the
internet infrastructure buildout. Such companies include Sun, which has
seen its revenue growth rate more than double due to relentless demand for
its high-end servers on the part of ISPs, and EMC, which has sold thousands
of terabytes worth of storage systems to insatiable internet portal
operators. However, when the dust's cleared, the "established" technology
company that may end up profiting the most from providing some of the
"picks and shovels" for the internet is Nortel, with its dominant position
in the market for high-end optical networking systems.
Given Wall Street's current obsession with all trends, technologies, and
companies related to the white-hot optical networking sector, it may be
hard for some to believe that only several years ago, optical networking
was a sleepy, low-growth industry, given little attention either by Wall
Street or the mainstream media. This was due to the fact that, at that
point in time, the overwhelming majority of all traffic being sent down
fiber optic networks was related to voice; or in other words, standard,
circuit-switched phone calls. Thus the growth in sales of new optical
networking equipment was directly proportional to growth in voice traffic
itself. As one might guess, it's been decades since voice could be
considered a growth industry, and so the growth in optical networking paled
when in comparison to that of industries such as personal computing,
business software, and wireless.
Then came the onrush of data traffic stemming from the internet, and the
industry was quickly turned upside-down. From the very beginning, internet
traffic grew at an exponential pace, although at first, it was only a blip
on the radar of most networks. Even as late as mid-1996, data only
accounted for 15-20% of all traffic on most backbones; but the nosebleed
growth rates for internet traffic refused to let up, and as the law of
exponential returns manifested itself, by the turn of the century, data
accounted for more traffic than voice on the majority of the world's
leading optical backbones. With data traffic, even after having grown so
much, still rising at well above a triple digit annual rate, even with the
technological advances that have dramatically reduced the costs related to
transporting a given amount of network traffic (to be further discussed
later), the optical networking industry has quickly roared to life.
Last quarter, it was reported that the industry at large grew by 66%,
roughly five times the rate at which it was growing in pre-internet days;
and with data traffic set to become an even larger percentage of total
network traffic in the coming years, this number should accelerate further
before beginning to decrease. The growth rates for data traffic itself
shouldn't slow much either. Numerous developed countries still have very
low internet penetration rates, and significant growth should come from
these markets as more individuals go online. Meanwhile, users in nations
with high-penetration rates such as the United States continue to sign up
en masse for high-speed services that result in users not only downloading
more content in general off of the internet, but also more
bandwidth-intensive content such as music files and streaming video clips.
The overwhelming amount of internet traffic created by broadband users
using file-swapping services such as Napster has already put significant
strains on the networks of a number of internet service providers.
Meanwhile, 56K internet users continue to increase the amount of time they
spend online, leading to network backbones becoming burdened more than
ever, even as the type of service being offered to such users remains the
same; and as video on demand and HDTV services begin to be rolled out,
requiring 6-8 mbps of bandwidth to be continually dedicated to a single
viewer, another optical capacity-draining application will have taken
flight.
Until recently, Nortel Networks was far from being a leader in the optical
networking market. That position belonged to its archrival, Lucent
Technologies. Even as new technological advances such as dense wavelength
division multiplexing (DWDM), which allowed multiple beams of light to be
carried on a single optical fiber, took flight, allowing innovative
upstarts such as Ciena to gain a toehold into this market, Lucent held
steady with its leading position, with Nortel playing second fiddle as late
as early '99. It was a this point that Nortel released its first DWDM
transmission and optical switching products supporting optical wavelengths
that carried traffic at a rate of 10 gbps, better known as OC-192. At this
point in time, Lucent, Ciena, Alcatel, Fujitsu, and the rest of Nortel's
competitors in this market, only had products that worked at 2.5 gbps
(OC-48). The general consensus among these companies was that the market
still wasn't ready for such high-bandwidth solutions as Nortel's, and thus
chose to more slowly develop their OC-192 products, focusing instead on
developing solutions that allowed for more beams of light to be transmitted
within a single fiber; in other words, a more flexible solution rather than
one that provides more bandwidth. Thus by pushing ahead with its OC-192
efforts, Nortel made a tremendous gamble...one that paid off brilliantly.
It would turn out that with internet traffic growth outstripping even the
most optimistic forecasts, carriers were hungry for solutions that could
provide as much bandwidth as possible in the most economical manner. With,
by far, the highest capacity optical transmission offerings on the market,
this resulted in an absolute bonanza for Nortel. In the course of a little
more than a year, the annual growth for its optical networking division has
soared from the 50-60% range to over 150%, and the company's market share
in the DWDM transmission market has skyrocketed to a gorilla-like 54.3%,
with no competitor, Lucent or otherwise, attaining half as much market
share. Meanwhile, in the larger optical switching market, Nortel's also
reaped great benefits from its OC-192 gamble, with its market share having
grown to a dominant 38.3%.
Those looking to find a weakness in Nortel's gleaming façade might be quick
to point out that its days of possessing a monopoly on the OC-192
transmission/switching market are now over, as most of its competitors
have, over the past few months, released products that run at similar
speeds. However, none of these companies are able to rival Nortel in the
number of OC-192 wavelengths that can be sent over a single fiber. For
example, Lucent's and Ciena's OC-192 systems can only handle 40 and 48
wavelengths, respectively, when compared to Nortel's 160; and perhaps more
importantly, it should be noted that just as its competitors have reached
OC-192, Nortel's leapfrogged them once again, having released a 40 gbps
(OC-768) DWDM system, and having demoed an 80 gb/s (OC-1536) system in its
labs (no lab tests conducted by any other company have gone beyond OC-768).
Last June, Qwest, using Nortel equipment, became the first operator to
commercially deploy an OC-768 system. Competing OC-768 systems aren't
expected to be on the market until next year.
While optical transmission speeds and switching capacities are of critical
importance to the viability of a vendor's offerings, the blistering growth
of internet traffic has also driven the need for advanced network
management software to be sold along with such equipment. Internet traffic
patterns, unlike those of their voice counterparts, tend to be very dynamic
and unpredictable, with traffic swelling tremendously one hour, only to
slow down just as quickly the next hour. Thus, if a carrier doesn't manage
the bandwidth it has on disposal in an efficient manner, it could be forced
to choose between having to deal with traffic overloads on certain portions
of its network on a regular basis, or with overspending to buy excess
network capacity that it could do without.
This has led to the need both for software that can intelligently monitor a
carrier's network, and give it the ability to dynamically reallocate
wavelengths from one fiber strand to another, so as to better handle
traffic problems, and for equipment that allows carriers to reallocate
wavelengths in a matter of hours rather than months, as this process once
took. Nortel's software products for this market, the Optera Network
Controller and Preside Network Management, which provide carriers with
advanced network monitoring/management capabilities, and with its Optera
HDX Connection Manager, one of the most flexible optical switches on the
market. However, as impressive as Nortel's products are, it does face
significant competition in this market from Sycamore Networks, which has
both a very robust optical switch in its SN16000, and, by many accounts,
the industry's most functional network management software product with its
SILVX Optical Network Management System. Still, it should be kept in mind
that while the SN16000 is a quality product when compared with offerings
from, say, Lucent, the switch still doesn't have OC-192 support, giving the
Optera HDX a significant advantage. Meanwhile, through its Preside
Commerce Hub product, Nortel has beaten Sycamore to the punch in offering
carriers the ability to use its optical switch to not only provision
wavelengths on demand, but also lease them to potential ISPs and business
customers, a feature that could bring carriers significant new
revenue-generating opportunities. When combined with the superior
technical features of the Optera HDX, it's easy to see that Nortel amounts
to a worthy competitor for Sycamore.
Although it's considered to be a high-end optical networking equipment
vendor, Nortel has also been able to realize that, given the increasingly
competitive nature of the carrier/ISP market, cost will become an
increasingly important issue for its customers when making future
purchases. A number of the company's recent acquisitions reflect this
understanding. One such acquisition was the purchase of Qtera, a company
whose transmission products allow a beam of light operating at OC-192 to be
sent 4,000 km without the need for conversion into electronic form, over
800 km further than the products of competitors such as Corning and Covis,
and over 2,000 km further than the offerings of most vendors. Electronic
conversions require the need for additional optical lasers to be used, and
thus tend to be very expensive. Thus a carrier could become partial to a
product such as Qtera's even if it isn't the highest capacity product
available for use within a given fiber, as the cost savings attained could
allow a carrier to implement two or three Qtera systems for the same cost
as one high-capacity competing system. However, considering that network
junctions on long-haul backbones generally take place every 500 km or so,
and using today's networks, optical signals have to be converted into
electronic form at every such junction, modern network architectures would
only allow Qtera's system to be fully utilized on trans-oceanic networks.
However, all-optical switches, set to be released within a year, should
change all of this by switching light in optical form. Here, Nortel
appears set to lead once again, thanks to its purchase of Xros, a company
that's developed the world's most scalable all-optical switch, possessing
twice as many as ports as those of its closest competitors. Last but not
least, Nortel's also recently acquired CoreTek, the leader in the nascent
tunable laser market. Tunable lasers provide significant cost-saving
opportunities due to their ability to allow carriers to significantly cut
down on the number of backup lasers they need to carry should a laser used
in operation break down (see my JDS Uniphase report for more details).
As of today, Nortel Networks trades at roughly 105x trailing earnings.
Last quarter, thanks to the blistering growth exhibited by its optical
networking division, the company grew its revenues by 48% annually. Next
year, Nortel's optical networking revenues, which should still be growing
in the triple digits at that point, are expected to account for over 65% of
the company's sales. By 2002, that number should be in the 75-80% range,
and by 2003, thanks to the percentage of sales coming from optical, the
growth exhibited by Nortel as a whole could be very similar to the growth
shown by optical networking "pure-plays" such as JDS Uniphase. Given that,
at this point in time, Nortel is trading at multiples that are far lower
than those of the companies that are in the same league as an upstart such
as JDS Uniphase, not to mention those of other, slower-growing blue-chip
tech companies such as Sun Microsystems and EMC, in the following years,
Nortel's share price could see significant appreciation not only due to
growth in the company's bottom line, but also in the richness of the
valuation that it's given by Wall Street.
Article written by Eric Jhonsa
Thank you and have a nice weekend,
The Fredhager.com Staff
(Voluntary Disclosure: Position- Long)
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Nortel Networks (NT) - News
InfoSpace, Nortel in alliance
Thursday, 14 Sep 2000, 9:10 AM EDT, Reuters Financial News
Toronto stocks mixed at midday on Nortel gains
Wednesday, 13 Sep 2000, 12:33 PM EDT, Reuters Financial News
Toronto stocks open mixed as Nortel gains
Wednesday, 13 Sep 2000, 9:58 AM EDT, Reuters Financial News
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