Optics' second wave swells
By Stephen Lucey
Red Herring
August 27, 2001
redherring.com
This article is from the August 15, 2001, issue of Red Herring magazine.
It might seem ridiculous for investors even to consider the stocks of companies involved in fiber optics right now. After all, Nortel Networks (NYSE: NT) recently chalked up a mind-boggling $19.2 billion loss in one quarter alone. Companies like JDS Uniphase (Nasdaq: JDSU) and Ciena (Nasdaq: CIEN) no longer seem to promise the type of hypergrowth that drew investors to the space in recent years. But that doesn't mean investors should write off optical companies altogether.
We think the next opportunity for growth in optics is in the capital-equipment makers -- specifically the test-and-measurement companies. They offer critical systems that ensure optical devices are performing optimally at both the physical and protocol levels of the network. As manufacturers continue to innovate, demand for specialized testing solutions is intensifying. And with so much fiber already in the ground, the value added comes from companies that can service these data pipes -- not necessarily those that design or construct new ones.
The optical-equipment sector is still in its infancy, but analysts liken the group to the semiconductor-equipment sector in the early '70s. Then, chip makers spent less than 5 percent of their sales on capital equipment. Today that figure is 25 percent, and a similar shift is expected to push the optical test-and-measurement sector from a $3 billion industry in 2000 to between $10 billion and $15 billion by 2005, according to Gregory Konezny, an analyst at U.S. Bancorp Piper Jaffray.
The company best positioned to capture the lion's share of this market is EXFO (Nasdaq: EXFO). The Canadian manufacturer is currently the only test-and-measurement company focused solely on the optics market. With 2,000 customers in 70 countries, EXFO made a name for itself in the early '90s as a low-cost provider of field-monitoring solutions.
TESTING, TESTING
As manufacturers begin to adopt more complete solutions for their equipment needs, especially for research and development, EXFO should continue to gain market share. Analysts expect half of the company's estimated $150 million in sales in fiscal 2001 (ending in August) to come from this growing segment. And with 33 percent of its revenue in fiscal 2000 derived from products introduced in just the last 24 months, EXFO is fast becoming the leading innovator in the market.
EXFO certainly hasn't been immune to the free-fall in optical stocks -- as of August 23, the stock was down 73.1 percent since the company's IPO in June 2000. But results beat analysts' fiscal third-quarter earnings estimates, and EXFO remains on track to post a revenue increase of 110 percent and earnings gains of 80 percent in fiscal 2001. EXFO isn't a cheap stock, at 32.1 times analysts' fiscal 2002 earnings estimates, but the valuation isn't unreasonable when you consider that analysts expect long-term earnings gains of 42 percent.
Another strong offering is Digital Lightwave (Nasdaq: DIGL), a small niche player focused on optical testing equipment for networks already deployed in the field. Although the company's products are not targeted for use in the R&D lab or on the manufacturing floor, analysts estimate that approximately 10 percent of its products are being used in those areas. Digital Lightwave had revenue of just $101 million last year, but it's growing rapidly, with long-term earnings growth estimates of 25 percent. Plus, the stock is the least expensive of the optical-equipment makers, trading at just 11.9 times 2002 earnings estimates.
Acterna (Nasdaq: ACTR) is a more diversified testing company, with products in the optical access, transport, and cable network markets. And with revenue of $420 million from its optics unit alone -- and total sales of $1.2 billion in fiscal 2001 -- Acterna offers investors exposure to a broader customer mix. Acterna is not growing as fast as EXFO or Digital Lightwave, with estimated earnings gains of 20 percent over the long term. But Acterna's stock is reasonably priced, at 15.5 times 2002 earnings estimates.
These companies may not lie in the most well-known part of the optical sector, but with solid fundamentals and attractive valuations, they're better bargains than the struggling optical components and networking companies.
Stephen Lucey is a freelance writer in San Francisco. Write to letters@redherring.com. |
