SMARTMONEY.COM: A Tale of Two Networkers >JDSU
Dow Jones News Service ~ January 19, 2000 ~ 6:00 pm EST
By Tiernan Ray
Smartmoney.com
NEW YORK (Dow Jones)--I know, I know. You've asked your doctor, and you've asked your co-workers. You talked with your better half, you even asked your mother. Still, you can't quite figure it out. Just what is a "subsystem"?
The tech industry throws out there lots of terms you won't find in the Cambridge Unabridged Dictionary, "Cosmo's Bedside Quiz Book," or the "Complete Book of Fly Fishing." We've taken a stab at many of them in this space. Still, though, all we have are clues that we use to poke around the edges of the phenomena. Subsystem is the latest impenetrable clue to a trend that is toppling valuations left and right.
Optical networking, so they say, is hot. The market has tired of talking about the acquisition by Cisco Systems (CSCO) last fall of a company called Cerent, an optical-networking company, at a cost of $6.8 billion. Instead, we like to talk these days about how problems in manufacturing optical-networking equipment made Lucent Technologies' (LU) stock drop 20 points on Jan. 6. Today, we can talk about how JDS Uniphase (JDSU) and E-Tek Dynamics (ETEK), with nary $ 300 million in sales between them, are worth $15 billion together.
Clearly, when a technology turns companies you've never heard of into stars, and established, "safe" stocks into troubled, risky ventures, you have to ask yourself every morning: Just what the hell is this optical stuff?
Ah, the subsystem question. Somehow, it is a clue to one of the latest, hottest optical companies, Finisar (FNSR). The phrase "optical subsystem" appears about 125 times in Finisar's prospectus. Subsystem was also on the lips of Uniphase's CFO, Anthony Muller, when I spoke with him recently. Does that mean that Finisar is perhaps the next JDS Uniphase-E-Tek, a company synonymous with optical networking, whose nearly 1,100% rise in the past year is another indicator that photonics can warp time and space?
In a word, no. Finisar is not JDS Uniphase, certainly not in the same sense that investors say "the next..." Since its IPO last November, Finisar is off 50% from its high of $127, which it reached on the second day of trading. And the stock dropped nearly 10% Tuesday while JDS Uniphase announced its intention to buy E-Tek. I'm not sure why Finisar's been losing air the past couple of days, except perhaps that, promising as the company may be, at a forward price-to- earnings ratio of 335 based on 2001 earnings of 20 cents a share, the company should never have been at $127 in the first place.
But Finisar is an optical company in its own right, and one with some promise. We're in the truth-in-advertising department here, folks, and there's a lot of what linguists call "semantic drift" when it comes to optical networking. There are at least two vectors along which to distinguish the optical folks: components vs. systems, and datacom vs. telecom.
Ordinary components, as opposed to finished systems, are the simplest atomic parts of an optical communications system. (Or should we be saying "photonic parts" these days?) Components can be divided into "active parts," which alter the light signal in some way, such as the source lasers that generate the optical signal the vast majority of which are made by Lucent's microelectronics division and "passive" components, things that don't alter the signal itself, including splitter-combiners for breaking up light waves into individual transmission streams. E-Tek makes a lot of these passive parts, and so does the JDS division of Uniphase. That means JDS may be cornering the market on passives, which is good for the company, because they are one of the hardest parts of any optical system to manufacture in volume.
At the other end of the food chain, companies such as Sycamore Systems (SCMR) make full-blown communications products - communications "gear," as we call it. Ditto for Ciena (CIEN) and Nortel Networks (NT). And all of these companies, component makers and systems folks are further divided into telecom or datacom, depending on whether their wares go into the public phone networks or corporate data networks. Basically, the public network products have to run at extremely high speeds, and they require fairly complex, expensive manufacturing processes. Think Sycamore here, and Ciena. The datacom world is less about lasers and more about cleaning up digital signals. Think Extreme Networks (EXTR), a gigabit ethernet company that buys from Finisar. This stuff is well-understood technology that has to be produced in high volume at a low cost.
Finisar is in the datacom world, a world dominated by software applications. Finisar's products are components, used in fast routers and switches to send billions of bits of data across a corporate network. Uniphase, also a component supplier, is in the telecom world, meaning it manufactures optical amplifiers that can boost the signal in fiber-optic cabling across distances spanning thousands of miles. Uniphase's work is at the edge of optical physics; the company enjoys a premium valuation because it is one of the few that can figure out how to manufacture passive components in volume. Uniphase is wrestling with science. As CFO Muller explained to me, "We're probably at the same stage in communications that the chip business was at 40 years ago, when we moved from discrete transistors to integrated circuits."
And that's where things get interesting for both companies. For the two worlds of datacom and telecom are converging, and that's the point of our tour of the subsystem. Somewhere between components and finished sytems are subsystems. Both Finisar and JDSU are selling something a little higher up than a component, but not quite a finished product, that adds some intelligence to the basic component. For example, JDSU will take the passive splitter-combiners and merge them with its expertise in pump lasers, and ultimately make an optical switch.
Finisar, on the other hand, buys a laser diode and attaches it to a microprocessor and a math chip known as a digital signal processor, or DSP, to create something that can not only transmit gigabit ethernet signals over a laser, but that can also clean up the signal on those lasers and monitor the transmission for errors.
The result could, down the road, be a great Mexican standoff. Finisar's customers, such as Extreme, typically sell their networking gear into corporate networks spanning a few hundred meters to a mile or two. But increasingly, carriers want to extend ethernet out across many city blocks, or even tens of miles, to create links to the Internet that look just like the extension of a corporate network. Companies that pull fiber, such as Metromedia Fiber Networks (MFNX), want to sell a bare cable, what's called dark fiber, to big Fortune 500 customers. Finisar's transceivers, with their ability to clean up signals, and to monitor the performance of links in a network, make it possible to extend the distance of ethernet and fiber channel inside fiber-optic cabling up to many miles.
And while Finisar is extending ethernet, JDS Uniphase-E-Tek wants to push fiber optics down to the customer. The big story in optics in the past two years has been dense wavelength division multiplexing, or DWDM, a technology for multiplying the capacity inside long distance fiber links. But by using E-Tek's passive splitters, and the passive components acquired in the merger with JDS last year, JDS can actually divide up the light at the end of a fiber cable in the last mile of the phone system, out near a customer, and send a stream of light to each home or business. It's been a Nirvana of communications for some time, and it may finally be arriving: the passive optical network to the home, bringing you gigabytes of data.
What will happen as these two very different optical companies, JDS Uniphase- E-Tek and Finisar invade each other's markets? Some customers will probably want the ethernet that Finisar sells because it helps them run certain programs on the Internet just as they would on their own private networks. Others will want all the bandwidth that a big fiber-optics stream can bring them. In other words, we'll probably say "Good, good and more good" to anything that even smells like fiber optics.
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(END) DOW JONES NEWS 01-19-00
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