Update: DWDM for Fiber Optic Networks
-- Research Notes
Subject: Lucent Technologies
(LU--$68.81) NYSE Opinion: BUY
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Date: June 2, 1998
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Market Profile
52-Week Range $79-$31 | EPS Growth Rate (3-5 Yrs.) 25%
Avg. Daily Volume 5,187 M | ROAE (LTM) 16%
Shares Outstanding 1304.0 MM | Debt to Total Capital 44%
Market Capitalization $89,731 MM | Book Value Per Share $3.58
Floating Market Cap. $79,861 MM | Indicated Dividend/Yield $0.16/0.24%
Institutional Owner. 41% | Revenue (LTM) $28,154 MM
Insider Holdings 11% |
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Earnings/Share Fiscal Consensus Fiscal
1Q/Dec 2Q/Mar 3Q/Jun 4Q/Sep Year Est. # P/E Ratio
------ ------ ------ ------ ------ --------- ---------
1997 $0.67 $0.05 $0.17 $0.28 $1.17 $1.17 58.1x
1998E 0.87A 0.14A 0.23 0.38 1.62 1.63 42.5x
1999E - - - - 2.00 1.93 34.4x
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HIGHLIGHTS:
- DWDM demand is the hot zone for boosting capacity of installed fiber optic.
- Right now, Ciena (CIEN-51, Buy) and Lucent are the 2 leading DWDM suppliers.
- Lucent sees the undersea and terrestrial, long haul segment dominating the
DWDM market through 1999 and 2000.
- This is contrary to Ciena's focus which is rapidly shifting to the local
exchange carriers like the RBOCs/GTE and then enterprise accounts.
- Nonetheless, Lucent will launch a metro product at SuperCom next week.
- Price target for Lucent remains $90 which is a deserved premium valuation.
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REASON FOR NOTE:
We spoke to Kathy Szelag, Director of Strategy in Optical Networking at Lucent.
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BACKGROUND:
DWDM is Dense Wavelength Division Multiplexing. It is more economic to boost
existing fiber optic capacity than to dig up the streets to install additional
fiber lines. DWDM is a high speed version of conventional wave division
multiplexing (WDM). It increases the capacity of fiber-optic transmission
systems through multiplexing of multiple wavelengths of light. Each wavelength
channel may support OC-48 (optical fiber) transmission at 2.5 Gbps. Of course,
continued refinement of DWDM drives even higher gigabit transmission capacity.
DOMESTIC DWDM MARKET:
Lucent is battling Ciena (CIEN-Buy, 51) for the race to capture early market
share for DWDM systems, potentially a $5 billion market by 2001. Recent awards
from large service providers like Bell Atlantic are going to a two vendor
model; so far Ciena and Lucent.
WorldCom was Ciena's largest customer in 1997. MCI Communications, soon to be
acquired by WorldCom, has selected Lucent's True Wave network manager for DWDM.
There are 4-5 planning activities going on between MCI and Lucent before we see
any real commercial orders. This must be watched carefully, because a big order
from WorldCom/MCI would be a victory for Lucent and put pressure on Ciena to
expand its customer base more rapidly from five to six service providers it
services today.
Will there be more competition? Yes. In the next 6-12 months, more suppliers
are coming into the DWDM market in the US such as Alcatel, ADC, Ericsson, NEC,
Nortel, Siemens, and Tellabs. Many of these world class suppliers will
announced DWDM products at SuperCom. Other competitors like Fujitsu and NEC
seem to be way behind in DWDM product development. The bottom line is the
world is behind US market developments in deploying DWDM. Cable & Wireless is
the most active using Ciena systems. This spells opportunity for all
suppliers, especially those that can stay at the cutting edge of DWDM trends.
Don't forget Cisco has strong ambitions to be a major player in the service
provider market for data networking. Ciena and Cisco have initiated an inter-networking
forum which will have its first meeting at SuperCom next week. Bothcompanies are working with Japan Telecom.
OTHER COMMENTS FROM OUR DISCUSSION WITH LUCENT:
In terms of the big picture, Lucent is a full systems integrator that
understands how to sort through the different technologies like ATM routers,
SONET and WDM. Truthfully, Ciena needs a partner to offer the depth of
services that Lucent can offer.
Lucent has some lead time over new entrants with 20-25 carrier trials that may
lead to potential contracts.
The company believes the 80 channel long haul DWDM product it is designing will
be 90% of the market in the next 3-4 years.
Lucent works DWDM through the three technology platforms - ATM, SONET and IP.
Right now, there is some early stage difficulty with IP but the upside of going
around the Sonet box drives network cost savings.
Lucent will still play the metro market with a 16 channel short haul product
ready for market trials. It will use lower power and cheaper amplifiers than
the ones used for the 80 channel long haul product. The local loop network can
not handle the same level of speed as the long haul market.
Lucent has done some trials with British Telecom. It will announce a metro DWDM
contract with Teleport, now owned by AT&T in the next week.
We believe Ciena's lead time may be 3-6 months for rollout of the metro
products. Its initial product would be a point-to-point system, not a ring
product.
At SuperCom, Lucent is also expected to introduce a high performance long-haul
amplifier which is about 90% complete.
Lucent is testing a DWDM product with IP routers north of Boston, MA.
DWDM is still too expensive for enterprise customers and is probably two years
away before the first signs of major demand from this market. Nonetheless,
Lucent will announce an enterprise contract in the next week.
ADC, a competitor, is working on a DWDM applications for the cable industry.
ADC hs been talking to set top vendors to move the product to market.
Ms. Szelag is not as optimistic as we are (or Ciena) on the 1999 demand for
DWDM from the local exchange market - interoffice rings and metro access
products. She believes it will take several years to grow DWDM in the local
market compared to the market size for the long haul market, both terrestrial
and undersea projects.
Lucent is providing the terrestrial optical cable transport for "Oxygen," a
proposed multi-billion dollar undersea network. The supplier of the undersea
cable will use DWDM applications.
INVESTMENT THESIS:
We believe Lucent shares will appreciate to match its attractive earnings
outlook. We have a bullish two-year earnings forecast. Earnings in 1998-1999
should grow in the mid-20% range, which would exceed the growth rates of most
of Lucent's peer group.
So far, management has exceeded investor expectations, but the bar continues to
be raised in terms of strategic and financial expectations. This quarter again
there are many earnings disappointments in the telecommunications equipment
sector. And yet, Lucent's track record remains strong but carefully watched by
the market with the stock trading at record levels. We remain bullish.
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