Is Optical Equipment Poised for a
Comeback?
By BILL ALPERT
In the crater left by the bursting of the bubble market, the lowest circle is
filled with optical network stocks. The road to that crater is paved with dark
fiber that we once thought would blaze with Internet traffic. To the devil with
JDS Uniphase and Corning!
How strange, then, to encounter Zhiping Zhao, a thoughtful Sanford C.
Bernstein analyst who has been recommending optical network stocks since
March.
"It's a view
that not many
people are
advocating,"
she says,
cheerfully.
While most
investors figure
they'll be
drying wet
socks on idle
fiber lines 'til
doomsday,
Zhao believes
that rising
traffic will
compel
telecom
carriers to start
buying optical
components
by year-end. That would benefit JDS Uniphase, the leading maker of optical
transmission components, and Agere Systems, the Lucent spinoff whose chips
connect optics to computer lines. She thinks JDS Uniphase could rise to 10
from its current price of 2.90. Agere could reach 7.50 from the current 1.84.
Amid the Internet bubble, optical preachers like George Gilder waved hands
and mumbled vaguely about rising Internet traffic. Bernstein's Zhao has found
something that she can observe and count: "network latency."
Latency is the transmission time required for a message to cross the telecom
link, after accounting for distance. If it rises too high, messages are probably
sitting in traffic queues awaiting a clear lane to continue their journey.
Network operators then face the choice of investing in additional transmission
gear or losing customers.
Latency always drops after capital spending. So Zhao figures that significant
rises in latency should likewise be a predictor of capital spending. The analyst
has spent a year observing two nationwide telecom networks (which she's
reluctant to identify). She aims to collect enough data to estimate how much of
a latency rise provokes how much capital spending.
Network operators won't say how much latency they think is too much, so
Zhao estimates a "normal" latency level for each network link she's
monitoring. Then she watches for an increase. To start, she's looking for a
20% increase over the baseline.
One sure thing is that latency is on the rise. On one network, the links showing
20% jumps in latency in the first quarter of this year rose from about 8% to
9%. Cash strapped operators have delayed investment and are running their
networks "hotter," explains Zhao, and at some point they'll need to increase
capacity. She believes this will happen by year-end. "I could be wrong by a
quarter," she says, "But I doubt I'll be wrong by a year."
The WorldCom debacle barely fazes Zhao. WorldCom's many business
customers will continue to need telecom services, and she predicts that they'll
flood into AT&T. Congestion on AT&T's network, therefore, will rise.
The least costly way of boosting capacity is to slide boards into the expansion
slots of existing systems. Another solution is lighting dark fiber by purchasing
optical amplifiers. Neither approach would help Corning sell fiber, but
component makers like JDS Uniphase and Agere would see orders.
While the 31 analysts surveyed by First Call rate JDS Uniphase, on average,
barely above Hold, Zhao rates the San Jose-based firm an Outperform. She
believes that revenues could bottom just above $1 billion in the just-finished
fiscal year ended June, then rise to $1.2 billion in June 2003 and $2.3 billion
in June 2005. After a loss of 12 cents, or $160 million, in fiscal 2002, Zhao
thinks JDS Uniphase will nearly break even in fiscal 2003 and make 26 cents,
or $350 million, in the fiscal 2005 year.
Agere has suffered, says Zhao, because investors see the firm as an optical
component supplier to Lucent. Most of the Allentown, Penn., firm's products
are semiconductors, she notes, with 60% of revenues coming from outside
telecom. Only 12% of revenues come from Lucent, which completed its
Agere spinoff last month. After a recent convertible bond offering, says Zhao,
Agere is well fixed for cash. She predicts a loss of $950 million, or 58 cents,
on sales of $2.25 billion for the year ending September 2002. Then Agere
should break even on $3 billion in sales in the fiscal 2003 year, and eventually
make $550 million, or 33 cents, on sales of $4.5 billion in fiscal 2005. |
