Anthony Tucker Research Report
OPTICAL CABLE CORPORATION (OCCF/OTC $14 3/4)(m)
INITIATING COVERAGE WITH A BUY RECOMMENDATION
SUMMARY
Optical Cable Corporation, based in Roanoke, Virginia, manufactures and markets a broad line of fiber optic cable used primarily to transmit data, voice
and video information. The company is the second largest supplier of tight buffered fiber optic cable in the "moderate distance" market segment
comprising cable runs up to ten miles.
The use of fiber optic cable has increased as the cost effectiveness of the technology has improved and the demand for higher capacity communications
circuits has increased. In 1996 the worldwide market for fiber optic cable was about $5.9 billion and growing about 20% per year. Optical Cable Corporation
(OCC) has focused on a segment of the market that addresses cable runs of less than ten miles and includes the wiring used to carry data in local area
networks (LANs), telephone company local loops and cable TV systems. By addressing this niche market, OCC has been able to grow somewhat faster
than the overall market, or about 25% per year over the last two years to $45 million in sales in 1996. With a differentiated product and a proprietary,
low-cost manufacturing technology, we believe that OCC is well positioned to continue increasing its share of a market that we expect to continue growing
at or above the current rate. We are initiating coverage of Optical Cable Corporation with a Buy recommendation.
A well established market trend. The increasing use of fiber optic transmission facilities in communications networks is well established. We
believe the need for increased communications bandwidth will continue to drive this major technology trend.
Positioned to take market share. OCC has positioned itself in the fastest growing niche market in the fiber optic cable market with a proprietary
manufacturing process and a superior product. We believe OCC is well positioned to accelerate its market share gains.
Accelerating earnings growth. We believe OCC's accelerating share gain will translate into a higher rate of growth for the company. We forecast
an increase from the 25% sales growth that has characterized the company recently to 45% per year or better.
Purchase recommended. We are initiating coverage of OCC with a Buy recommendation. Our 12-month price target is $18.
Background
The advantages of optical fiber as a communications medium has been recognized since the technology was developed in the mid-1970s, but the cost of
the optical fiber and the associated electronics prevented its deployment until the mid-1980s when single-mode fiber optic systems began to be installed in
the long distance transmission facilities of the telephone companies. Essentially all terrestrial and submarine communication systems now use fiber optic
cables and, as the economics have continuously improved and the demand for bandwidth has increased, fiber optic cable is being used in more and more
applications.
The main advantage of optical fiber as a communications medium is its high transmission capacity, also known as bandwidth. Compared to the highest
speed copper cables, a fiber optic cable has thousands of times the information carrying capacity while occupying less space and operating more reliably
over longer distances. In addition, it is immune to electromagnetic interference and electrical surges. Because it does not carry electricity, it is safer in
flammable environments. It also offers higher security since it is difficult to tap without detection.
The economics of fiber optic systems have improved steadily, allowing the use of fiber optic cable in more and more applications formerly served by copper.
In the future, we expect that optical fiber will be widely deployed, not only in long distance telephone circuits but also in telephone company local loops,
commercial buildings, cable TV systems and data networks, including LANs and campus-wide networks. Gigabit Ethernet, the next high speed data
networking technology, requires fiber optic cable to operate over any meaningful distance.
The Market Opportunity
The world market for fiber optic cable in 1996 was about $5.9 billion, and has been growing at about 20% per year. This market is comprised of two main
forms of fiber optic cable, single-mode and multi-mode.
For long distance transmission, single-mode is the preferred technology, offering high capacity and low attenuation over long distances. The associated
electronics and connectors are expensive, but since the typical system has long cable runs between the electronics, the economics of the system remain
attractive.
Single-mode fiber currently represents about 90% of the unit volume of fiber optic cable and about 80% of the dollar volume. The largest application for
single-mode fiber optic cable is in long distance terrestrial and submarine telephony applications. In 1996, the market for single-mode fiber optic cable was
about $4.5 billion with a projected growth rate of about 20% per year.
Multi-mode fiber offers advantages in applications where the transmission distances are shorter than in the long distance market. The electronics and
connectors for multi-mode fiber are less expensive, thus improving the economics of a system, such as a LAN, where, compared to a long distance
installation, there is relatively more in the way of electronics and connectors and less in the way of optical fiber. The lower unit volume of fiber optic cable
used in these mostly medium-distance applications is reflected in a lower share of the overall market. In 1996, the market for multi-mode fiber optic cable
was about $1.1 billion with a projected growth rate of about 22% per year.
OPTICAL CABLE CORPORATION
Optical Cable Corporation was founded in 1983 by two engineers who had been responsible for the government-funded fiber optic cable development work at
the ITT Electro-Optical Products Division in Roanoke, Virginia. During the late 1970s and early 1980s, ITT captured nearly all of the government-funded R&D
programs for development of fiber optic components and systems, including the development of extremely strong, lightweight and rugged fiber optic cable
for military use.
From its inception, OCC pioneered the use of military tactical cable technology, combined with advanced manufacturing techniques, to offer new cable
designs specifically optimized for the requirements of moderate-distance LAN installations. This cable differed significantly from the cable being
manufactured by the major suppliers for the long distance market.
Because the early single-mode fiber was relatively brittle and subject to damage through rough handling, the manufacturers of single-mode cable adopted a
technology known as "gel-filled loose tube" (GFLT) in which the fiber strands "float" in a viscous gel inside a hard outer casing. Produced in large volume
and cost effective for long distances such as between cities, GFLT cable is difficult to use and expensive to terminate. The majority of fiber optic cable
produced today is still GFLT although it is losing share to a newer technology.
Using technology that had been developed for tactical military cable, OCC pioneered the production of a "tight-buffered" design in which the outer jacket of
the cable is extruded under high pressure directly over the cable's core, resulting in a cable that is more flexible and more durable than the gel-filled cables
and also permits a simpler and less expensive method of termination. Unlike the gel-filled cable, which cannot be used indoors because of the volatility of
the gel filling, the OCC tight-buffered cable can be used both indoors and outdoors.
Markets
The introduction of OCC's improved optical cable coincided with the rapid growth of networking and the company found a ready market for its products in
the wiring of buildings for local area networks. To date, optical fiber has been used mainly for network backbones using FDDI (fiber distributed data
interface), a technology built around optical fiber as a transmission medium. With the advent of additional high speed backbone technologies such as ATM
and Gigabit Ethernet, both of which require the higher bandwidth provided by optical fiber, the market for fiber optic cable in LANs is expected to show
dramatic growth over the next several years.
In addition to LANs, we expect OCC's tight-buffered cable to find additional applications in the medium-distance fiber optic cable market, defined as cable
spans less than ten miles. We believe GFLT fiber optic cable will remain the dominant product in long haul telephone networks. The large cable
manufacturers have significant manufacturing capacity committed to GFLT technology and the high volume insures a low unit cost. However, over shorter
distances, where installation and termination costs are a larger part of the overall system expense, tight-buffered cable, while more expensive than GFLT on
a unit basis, can often achieve a lower total installed system cost. Other applications included in this market sector include the local loop of the telephone
network, cable TV systems, building and campus communication systems and traffic control systems. About half of the fiber optic cable used in the
medium-distance market today is GFLT.
Cable for LAN applications currently represents about 75%-80% of OCC's business, with industrial applications another 15%-20%, video about 5% and
military less than 5%. Single-mode cable is currently about one-third of OCC's business and is growing faster than multi-mode cable as its use increases in
the telephone company local loop, CATV systems and among OEM manufacturers in the telecommunications equipment market who use it for
terminations, jumpers and patch panels associated with their fiber optic system components.
The telephone company local loop, which represents about 90% of the cable footage in the telephone system, represents the largest potential future
market. This market has not yet developed, as the installed copper plant, upgraded with electronics such as digital subscriber loop carrier (xDSL), appears
to still meet the demands of the local loop. However, over time, as the demand for bandwidth in the local loop continues to increase and the economics of
fiber optic systems continues to improve, this market could be substantial.
Products
With its highly flexible manufacturing facility, OCC can manufacture literally thousands of different fiber optic cables to meet the exact specifications of a
particular job. The product line is described in a detailed 128-page catalog which allows the customer to define the exact specifications required for an
application. The company offers three distinct types of cable construction in three basic cable styles using both single-mode and multi-mode optical fiber.
Rather than limiting its customers to just standard products, the company will also help customers identify special requirements and will supply
appropriately designed products.
OCC believes its tightly buffered cable provides at least eight advantages over its competition: 1) better protection in wet environments resulting in longer life
and increased reliability, 2) proof testing at higher stress levels to provide longer cable life, 3) an exclusive cable jacket design that provides better crush
and impact protection and improved tear resistance during installation, 4) a 25% improvement in temperature range, 5) lower termination costs, 6) flame
retardant materials and design, 7) dual indoor/outdoor use and 8) higher density packaging resulting in the smallest band radius in the industry.
In addition to its standard and custom cables, OCC also manufactures private label cables for customers and competitors in other segments of the fiber
optic cable market.
Distribution
The company sells direct to the U.S. Government, original equipment manufacturers and some Regional Bell Operating Companies, but about 80% of
OCC's sales are through national distributors such as Graybar, Anicom and Wesco, as well as strong regional datacomm distributors. The company has a
26-person outside sales force managed by three regional vice presidents whose job is to develop sales situations for the company's distributors. This
organization is supported by six inside salespeople who take orders and provide quotes and twelve sales associates who leverage the outside sales force
by looking for new business opportunities for the sales force to call on.
Outside the U.S. OCC also sells through distributors. OCC's international sales were about 25% of total sales in 1996 and are expected to increase to 50%
or more over the next two years. The foreign manufacturers of fiber optic cables have benefitted for years by the price protection afforded by the state-owned
telecommunications authorities. With the advent of deregulation around the world and especially in Europe, these protected competitors with essentially
non-competitive plants are expected to lose market share to U.S. competitors. We further expect OCC to gain market share from its U.S. competitors as it
has been doing in the market for tight buffered cable.
In 1996 no single customer accounted for more than 5% of its net sales, although one distributor accounted for about 12% of sales. The company does
business with over three thousand customers and over 80% of the orders are under $50 thousand. Both of these factors tend to stabilize order flow. Sales
are somewhat seasonal with softer business in the first two quarters due to the impact of winter weather on outside construction. Revenue in each quarter
results from orders received in that quarter and the backlog is not indicative of future sales.
Competition
The largest competitor for fiber optic cable is copper wire, the established legacy technology. While fiber optic cable has shown dramatic growth over the
last ten years, it has had an insignificant impact on the growth of the market for copper-based cables. This will continue to be true for the foreseeable
future, even as the economics of optical fiber continue to improve and the demand for increased bandwidth grows. Within the overall fiber optic cable
market, GFLT technology represents the largest competitive product.
Among the suppliers of fiber optic cable, Siecor, a joint venture between Siemens and Corning, and Lucent are the leading manufacturers of fiber optic
cable for both the long distance telephone and the moderate distance market. Although FGLT cables represent the largest part of both Siecor's and
Lucent's production, both also manufacture tight buffered fiber optic cable for the moderate distance market.
OCC believes that it is the second largest supplier to the tight buffer, moderate distance market behind Siecor and that it has been growing faster than
Siecor for the last several years. OCC believes that it can achieve the leading share of this market in the next several years, with continued market share
gains in the U.S. and an aggressive expansion of its international business.
Manufacturing
Manufacturing consists of applying a variety of raw plastic materials to optical fibers. The key material in this process is optical fiber which the company
obtains from several suppliers, including Spectran, Corning, Lucent and Alcatel. Corning and Lucent dominate the world market for optical fiber with a
combined market share estimated to be over 45%. The company maintains multiple sources for all of its raw materials. Because all of its optical fiber
suppliers are also competitors in the market for finished fiber optic cable, OCC has considered from time to time integrating backwards into the
manufacture of its own optical fiber.
While none of the company's current manufacturing processes or products are protected by patents, the company believes that its proprietary knowledge
with respect to the development and manufacture of fiber optic cables is a significant competitive advantage. The company also believes that its
computer-controlled manufacturing equipment, which is developed by the company and manufactured to its specifications, enables the company to produce
fiber optic cable of higher quality and at lower cost than its competitors. All the company's manufacturing processes meet required worldwide standards
and its Quality Management System is certified to meet ISO 9001. The current plant, while operating at a high level of efficiency, has substantial excess
capacity, as a result of a capacity expansion completed in January 1997, that enables the company to respond quickly to special customer requirements
and will enable the company to accommodate sales growth going forward.
Management and Corporate Developments
Robert Kopstein, Chairman of the Board, President and Chief Executive Officer, founded the company in 1983 as a partnership with a fellow engineer from
the ITT Electro-Optical Products Division in Roanoke, Virginia. Both had had extensive experience in the development of optical fiber technology for military
applications. Mr. Kopstein bought out his partner on June 22, 1989, and operated the business as a Subchapter S corporation until the company's public
offering on April 1, 1998. Unable to obtain a satisfactory underwriting commitment from the investment banking community, the company advertised and
successfully executed its own public offering, selling 2.675 million shares of the Company's common stock from which it received net proceeds of
approximately $5.8 million. The company currently has about 38.7 million shares outstanding, of which Mr. Kopstein owns 93% or 36.0 million shares. The
remaining 2.7 million shares are the publicly traded float.
The other senior officers of the company are Luke Huybrechts, Senior Vice President of Sales, a colleague of Mr. Kopstein from ITT, and Kenneth Harber,
Vice President of Finance.
Financials
OCC has operated profitably since its inception, achieving record sales and earnings in the fiscal year ending October 31, 1996, of $7.5 million in net
income or $0.19 per share on sales of $45.2 million. We are estimating earnings of $0.23 per share on sales of $55.6 million for 1997 and $0.38 per share
on sales of $81.2 million for 1999.
The business is seasonal to a degree because weather in the winter can delay the installation of outdoor cable. Thus OCC's business tends to be stronger
in the second half of the year compared to the first half. In the current year, second quarter sales were impacted by bad weather in Europe, which had the
worst winter weather in memory, and a general softness in telecommunications related spending in the major European economies. We expect sales to
rebound strongly in the third and fourth quarters and to continue a seasonal pattern in 1998.
The balance sheet is clean. Cash was reduced in the first half of FY 1997 to $350 thousand because of the company's investment in an expansion of the
existing plant. With less than $2.0 million of capital expenditures planned, we expect cash to be rebuilt to over $12.0 million in 1998. Accounts receivable
were 67 days sales at the end of the second quarter and inventory turns were 4.2 times.
Valuation
Currently selling at 38.8 times October 1998 estimated earnings, the stock is not inexpensive at $14 3/4. However, it is selling near the low end of its
historic P/E range, having recovered somewhat from the price decline following the weak second quarter report when the stock fell to a 62-week low of $7.
We believe that earnings will show a strong rebound in the third quarter and that the stock is not likely to revisit these lows anytime soon. Thus we do not
believe in waiting for the stock to pull back.
With an EPS growth rate going forward of 35% per year or better, we believe the stock can command at least 30 times forward 12-months earnings. Using
a preliminary estimate for FY 1999 of $0.60 per share, our 12-month price target for the stock is $18.
To receive additional information on Optical Cable Corporation, via fax, at no charge, dial 1-800-PRO-INFO and enter code OCCF. Or use this link
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