JDS, Corning Bet on Truck Parts, Paint as Phone Business Fades
(Published in Bloomberg Markets magazine.)
Corning, New York, Dec. 31 (Bloomberg) -- Ken Bradley, chief
procurement officer at Nortel Networks Corp., used to spend days
at a time pestering Bill Morris at Corning Inc. for more fiber-
optic components.
It was 2000, the height of the telecommunications boom.
Bradley wanted amplifiers and filters to build equipment for phone
companies like WorldCom Inc., which were racing to keep pace with
Internet traffic.
``Our customers were beating us up because they wanted to be
first to deploy their networks,'' says Bradley, 55, who retired in
April. ``In the same way, we were beating up Corning.''
Today, telecom companies and equipment makers are fighting
for survival rather than for parts: Brampton, Ontario-based
Nortel, once the largest builder of fiber-optic gear, lost $31
billion from 2001 through the third quarter of 2002. In July,
WorldCom, the No. 2 long-distance company, filed for the biggest
bankruptcy in U.S. history. Phone and cable company spending
dropped 29 percent from its 2000 peak to $215 billion in 2002.
Spending won't reach $215 billion again until 2006, according to
South San Francisco, California-based researcher RHK Inc.
Shares of Nortel, Corning and No. 1 fiber-optic parts maker
JDS Uniphase Corp. have tumbled 97 percent or more from their
highs. All told, the market value of the industry's top 10
suppliers has plunged by almost $1 trillion.
The industry's worst slump is forcing Corning, JDS and Lucent
Technologies Inc. spinoff Agere Systems Inc. to dust off products
they'd relegated to the backseat during the telecommunications
heyday.
New Job
For Corning's Morris, the end of the boom means a new job.
Instead of doling out optical parts as a Corning supply manager,
he's pitching Caterpillar Inc., Cummins Inc. and Ford Motor Co. on
the company's ceramic compounds that reduce pollutants emitted by
the diesel engines in heavy-duty trucks.
Some investors say initiatives like Corning's make sense.
``Anything these companies can do to generate sales and cash flow
would be a positive,'' says Daniel Morgan, who helps manage $100
million at Noble Financial Group Inc., which owns Nortel and
Corning convertible bonds.
Others question whether secondary businesses can make a
difference. ``I'm not sure it's all that relevant,'' says Walter
Casey, an analyst at Banc One Investment Advisors, which oversees
$155 billion and owns JDS and Corning shares. Corning shares
closed at $3.11 yesterday, down 97 percent from a September 2000
high.
Across the U.S. from Corning, New York, JDS's Joseph Zils is
on the lookout for new customers. JDS is depending on Zils's Santa
Rosa, California, Thin Film Products division after losing $56.1
billion in fiscal 2001 -- the most lost by any U.S. company in a
single year.
Front Burner
Zils's unit makes a hodgepodge of nontelecom products:
coatings for lenses in projection TVs, lasers for industrial
printing presses and pigments that deter the counterfeiting of $20
bills. The division will contribute almost half of JDS's $150
million to $160 million fiscal second-quarter revenue, says Chief
Financial Officer Anthony Muller -- more than double the
percentage a year earlier.
``If we hadn't seen the decline in telecom, we may never have
heard about much of this activity,'' says Peter Conrad, an analyst
at Kopp Investment Advisors, which manages almost $2 billion and
owns JDS shares. ``You'll see some instance
Few Options
Smaller companies like New Focus Inc. have few options except
change. In 1997, the San Jose, California, company developed its
first telecommunications product: a laser used in machines that
test networking equipment. It made two acquisitions, sold shares
to the public, built a 243,000-square-foot factory in Shenzhen,
China, and waited for orders to roll in from Alcatel SA and Corvis
Corp., says CFO William Potts.
The orders never came. In March, New Focus closed the plant.
Two months later, it sold its telecommunications assets to Intel
Corp. and Finisar Corp. for about $62 million. Now it's developing
parts for medical testing equipment and machines that measure the
depth of rivers. Along the way, it's shed 86 percent of its 2,100
workers and 97 percent of its market value, trading yesterday at
$3.70.
Fresh Start
The odds of making a fresh start are slim. As much as 90
percent of the hundreds of small telecom suppliers won't survive,
says Ajit Shah, general partner at venture-capital firm Worldview
Technology Partners in Palo Alto, California, which backed phone
equipment startups Tellium Inc. and Corvis. Companies that funded
nontelecommunications products in the 1990s or developed chips,
lasers or materials that translate into new markets have a better
chance of survival, Shah says.
Many investors are skeptical that suppliers can change
direction. With sales falling, corporations may be hard-pressed to
spend enough on tuning up businesses they viewed as afterthoughts.
Corning, for one, cut its research budget to $375 million in the
first nine months of 2002 from $484 million a year earlier.
``Where do you get the capital to reinvent the company?''
asks James Lyon, a money manager at Oakwood Capital Management
LLC, which has $340 million in assets and had sold most of its
communications equipment stocks by July 2001. ``You're not getting
it from current cash flows, and no one is going to pony up capital
in the private or public market unless they feel there's a
turnaround story.''
Turnaround Ahead?
The equipment industry's top executives -- Nortel Chief
Executive Frank Dunn, Corning CEO James Houghton and Lucent CEO
Patricia Russo -- predict a turnaround. They say phone company
spending will pick up or at least stop falling.
``It's in the doldrums now for sure, but I don't look upon
this as being a business that has eclipsed,'' says Houghton, 66,
from a 23rd-floor conference room in Corning's office in
Manhattan's General Motors building. ``It's going to come back
strong,'' says Houghton, who returned as chairman in June 2001 and
added the CEO post in April 2002 after retiring from both jobs in
1996.
Houghton is acting on his bet. As of Dec. 1, he, six Corning
directors and several executives had bought a total of 3.4 million
Corning shares during 2002, according to the Washington Service,
which tracks insider buying and selling.
Until the hoped-for revival, companies are weighing methods
of funding the research and capital needs of secondary divisions
without gutting phone-related businesses that may again become
moneymakers. It's a tough balancing act.
Watching Every Dollar
``The process this year is far more critical than in years
past,'' says Mark Bieberich, senior analyst at researcher Yankee
Group. ``Every dollar they spend has to be justified.''
JDS is figuring out what to do with $40 billion of
acquisitions after sales plunged by two-thirds to $1.1 billion in
fiscal 2002, ended in June, from $3.23 billion a year earlier. JDS
shares tumbled to $2.45 yesterday from a high of $153.42 in March
2000.
When telecommunications companies were surging, Thin Film
President Zils had 450 workers building filters that direct data
through optical networks. ``We have about 40 people focused on
that activity now,'' says Zils, who joined JDS with its February
2000 purchase of Optical Coating Laboratory Inc.
Zils, 48, says he expects sales of his division's films,
industrial lasers and lenses to rise 5 percent to 10 percent a
year. In the quarter ended Sept. 30, his unit had an operating
profit of $9.1 million on $84 million in sales, or 44 percent of
JDS's revenue. JDS's communications products division, which
houses its fiber-optic components and testing equipment
businesses, lost $85.1 million during the same period.
`Monument to Telecom'
Since early 2001, Zils has added 300 engineers and staff even
as JDS has slashed more than two-thirds of its 28,677-strong
workforce. To get to their jobs on the 75-acre campus nestled in
California's wine country, employees walk past a vacant, 150,000-
square-foot plant built last year to manufacture filters for
Lucent and Nortel equipment. ``A monument to telecom,'' says Zils,
smiling behind his mustache.
Half of Zils's 14 plants run 24 hours a day. Several produce
the unit's trademark thin films -- coatings that reduce glare on
computer monitors or that block extraneous electrical signals in
automated teller machines. The same plants produce a veneer that
gets ground into a powder to create inks and paints that appear to
change colors in everything from euro and Chinese renminbi bills
to writing pens.
Consumer Favorite
Michael Cohen, director of research at Pacific American
Securities LLC, is betting color-shifting paint will become a
consumer favorite.
Volkswagen AG has rolled out two color-changing options for
select 2003 Beetles: green to silver and cyan to purple. By the
end of November, the German automaker had sold 201 of the 400
special Bugs, charging $2,400 extra for the package that includes
the changeable paint, spokesman Steve Keyes says. The paint job on
Zils's Ford Taurus shifts to turquoise from amethyst depending on
how the light is reflected.
Cohen, who owns 3,500 JDS shares, says he believes people
will snap up gadgets like color-changing CD players. He says
Zils's collection of films and lenses will generate gradual sales
and profit growth, thereby buying JDS time to wait for a
telecommunications recovery.
For other companies, migrating from one market to another
won't be easy, especially if executives ignored smaller units in
more robust days, says Joseph Bower, Harvard Business School's
Donald Kirk David Professor of Business Administration.
``When you're struggling to fix your main business line, the
obvious thing is to throw everything you've got into it,'' Bower
says. ``Diversifying into a new business is one of the hardest
things for a company to do, particularly when people are
distracted.''
$100 Billion Business
Lucent found out firsthand how hard setting up a new company
can be. In early 2000, analysts and investors were predicting that
Lucent's plan to spin off its microelectronics division would be a
sure success.
The unit boasted one of the most advanced lines of components
for fiber-optic equipment, says Jeremey Donovan, chief analyst at
Dataquest Inc., a market researcher. And the business benefited
from the cachet of Bell Labs, Lucent's research arm, which had
invented the laser and a way to transmit information digitally --
discoveries that make fiber-optic networks possible.
At the time, analyst Greg Geiling, then at J.P. Morgan
Securities Inc., valued the microelectronics division -- later
called Agere Systems -- at almost $100 billion.
Tony Grewe, a director of strategic marketing at Agere, says
analysts urged Lucent to scrap everything but optical parts before
taking Agere public. ``If we had done that, we would have been in
dire straits,'' Grewe says.
`Not Much Upside'
By the time Agere was ready to sell shares, demand for fiber-
optic equipment had tumbled. Starting in January 2001, underwriter
Morgan Stanley dropped the initial public offering price three
times. When the stock made its debut on March 27, 2001, Agere was
worth $9.8 billion -- about one-tenth of the most bullish
projections.
Agere struggled with its optical parts business until October
2002, when it agreed to sell most of the division to TriQuint
Semiconductor Inc. for $40 million in cash.
Today, Agere's biggest business makes chips for disk drives,
handheld computers and video game consoles. ``The market is quite
competitive,'' says Dataquest's Donovan. ``There may not be much
upside.''
At Corning, Morris, 44, says he's applying what he's learned
in 22 years at the fiber and optical components divisions to his
new job working with diesel engines.
For investors, the bigger question is whether Corning and its
peers will be successful in making the same leap. |
