From Deutsche Banc Alex Brown's Fiber Optics Review:
November 1, 2000 Deutsche Banc Alex. Brown
US Optical Networking 1
MARKET NEWS
Optical Anxiety
Investors rushed for the exits in the confusion surrounding the results announced in the Nortel conference call. The fear was that yet another technology “bubble” has burst. The revenue miss by Nortel, on the heal of Lucent’s struggle and lingering carrier capex concerns, unleashed powerful investor anxieties. Nortel revenues of $7.3 billion were at the lower end of consensus that ranged up to $7.6 billion, while earnings of $0.18 beat expectations. Although the company was not forthcoming with details about
the inventory and installations issues it cited as the reason for the sequential decline in optics we believe the issue came from SONET equipment. (We note that component manufacturer JDS Uniphase has no exposure to Nortel
SONET equipment, only to DWDM.)
Nortel’s announcement drove the technology space down hard on October 25th as confusion and concern surrounded John Roth’s (Nortel’s CEO) statement that service provider customers had built up inventory levels in the prior quarter, adding fuel to lingering capex concerns.
Furthermore, Nortel announced that it no longer saw optical components as a bottleneck which investor took to be a sign that the component companies were late to see the decline in demand for optical networking.
We believe demand for optical components remains strong as demonstrated by the recent upwards revisions to RHK’s terrestrial component projections; and the strong results and increase in guidance in pure-play component companies following their quarterly conference calls (summarized in the table below).
Investors have reacted to a combination of three factors: capex concerns, Lucent’s issues and the Nortel conference call. We review each of these factors below and address why we feel they are not indications of an imploding “optics bubble.”
Firstly, carrier capex. We believe that carriers will continue to focus on optical transport as the only economical means to handle the bandwidth demand, in addition to optics’ ability to provide immediate revenue benefit due to the ease of provisioning. In this regard, North American carrier capex focused on the optical transport segment is expected to grow approximately 38%rising to $29 billion in 2001 from $21 billion in 2000. However, overall North American carrier capex is projected to grow 21% in 2001 to $133 billion from $110 billion in 2000, according to RHK. The growth in the optical transport market is being lead by next generation optical networking/DWDM which is projected by RHK to grow 167% in 2000 and 63% in 2001 while SONET is projected to grow 43% and 30% over the same periods.
We also feel that beyond DWDM transport there are significant opportunities emerging in the metro/optical edge and in core optical switching. According to Pioneer Consulting the Metro/Optical Edge market is expected grow to $8.3 billion in 2004 from $1.2 billion in 2000. And the core optical switching market is projected to grow $15 billion in Europe and North America by 2004 from approximately $544 million in 2000.
The component segment likewise remains robust and we do not believe that the component companies are facing an over build at this point. In fact, with the notable exception of the Nortel call, all indications are that the industry remains capacity constrained, despite continued increases in capacity. In fact estimates for the terrestrial DWDM component market have been raised for 2000 from approximately $2.5 billion to approximately $4 billion, according to RHK. And given the early introduction of certain new passive components in the market RHK estimates the 2000 terrestrial component market to actual be close to $5 billion – or in other words the equivalent of their original 2001 projection!
Secondly, Lucent’s issues. In our view, the difficulties at Lucent have existed for several quarters and are company specific. The problems the company is facing in the optical systems business are the result of missing a key product cycle (OC-192), and a lack of execution – not from any lack of demand! We note that despite the miss in the latest quarter Lucent’s Microelectronics business was up 50% over the prior year which implies that the optical components business grew an estimated 80% to 100%.
Finally, the Nortel conference call. While Nortel official guidance for optical revenues is $10+ billion, management in the past had encouraged this to be interpreted to mean something closer to $12 billion. When Nortel revenues for the third quarter came in at the lower end of estimates and optics revenues were down sequentially there was tremendous disappointment. Management was not clear in its explanation on the conference call and did not “block and tackle” the issues. We believe the decline in optics revenues was the result of issues in SONET equipment (particularly inventories held by WorldCom) and NOT next generation DWDM equipment. That said, it is important to take note of the positive news drowned-out by the confusion surrounding the revenue miss. Specifically, the metro market results were strong and management implied a 40% sequential increase in optics revenues for the fourth quarter. In summary, the immediate outlook for optics at Nortel is positive and all indications are that the optics issues raised in the conference call were specific to Nortel.
With most vendors reporting they remain constrained by component availability, increasing optical capex, and significant metro and core switching markets only just beginning our view is that the optical networking sector is robust. We consider the current weakness as an excellent opportunity to establish positions in companies with proven track records.
>>>>>>
I'm currently researching the ULH market and the impact on SDLI. I believe we'll see the first trans-continental ULH networks in operation by the end of 2001 and no matter whose systems they use --- NT, Corvis, or TerraWorx (TCM) --- SDL will benefit as they are the only component vendor shipping certified Raman amplifiers, one of the enabling technologies.
As for market volatility, I sincerely hope everyone who believes in the all-optical future can/will take advantage of the drops --- that is once you're comfortable we've turned around. I'm not recommending heroics.
And, now, totally off topic, if you get a chance to see the recently-released British film "Billy Elliot," don't miss it. With hints of "October Sky," "The Full Monty" and "Educating Rita," it surpasses them all. Julie Walters reverses her role in Educating Rita as Billy's dance teacher. Their dance duo, "I love to boogie," is worth the price of admission all by itself. Jamie Bell as Billy is brilliant. If he doesn't win your heart, you don't have one. Set against Margaret Thatcher's shut-the-mines government, the story is one of parallel struggles to find one's way in a rapidly changing world -- a world where walls of stone and steel are easier to scale than those of prejudice and fear.
There are several heroes, among them Billy's dad, played by Gary Lewis.
Warning, if anyone has (or had) a grandparent you love as much as life, take along a good supply of Kleenex.
billyelliot.com
[Click on trailer. . .]
Pat |
