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Should we be shouting, 'Encore, encore'?
By Kevin Slocum and Robert Mandra
2000 probably won't be a repeat of the 1999
boom in the photonics industry. But don't
worry.
In February 1998, SoundView published its first
industry report on photonics for investors. We
were promoting photonics as an area we
believed would produce great returns in the
years ahead. We described the efforts of a
couple dozen companies that were either well
established in the sector or that seemed to be
doing leading-edge development work. At the
same time, we attempted to describe the
devices the companies made and their
functional capabilities. To many of you readers,
this stuff would have been old hat, but to our
audience, what we were talking about was a
completely different language.
We placed what we'll call a cute tag line on the
report, "Ride the Wavelength." Our purpose in
doing so was to send a message that we
believed the photonics industry represented
more than just a nice trade, but also a real
investment opportunity. When 1998 drew to a
close, the group certainly had been interesting,
but the spectacular rise and fall of CIENA tied
to the aborted Tellabs merger and the collapse
of Corning's fiber business in part precipitated
by the global liquidity crisis, dampened the
group's performance. So we had more of a
choppy start than a wave.
Of tidal-wave proportions
We nonetheless stuck with our story in 1999,
and the choppy start turned into a tsunami. As
we wrote this column, SoundView's Photonics
Index had risen 258% compared to the overall
SoundView Technology Index at 68%. The S&P
500 Index was on a different radar screen
altogether, up about 12%. The question we are
asked lately, of course, is, what now? The
answer for the industry is probably easier than
it is for the stocks of the various industry
participants.
We believe 2000 will be another great year for
the industry. The public component companies
such as JDS Uniphase, SDL, and E-TEK
Dynamics have done a phenomenal job boosting
capacity and bolstering their product lines,
sowing the seeds for continued strong sales
growth. The system companies seem to be
moving to either next-generation products or
new classes of products. Sycamore for instance,
with the SN 8000, is attacking the
ultra-long-haul DWDM market with a platform
that offers more granularity in the speed of the
pipe in addition to the greater reach of the
system. In the new markets category, CIENA
with CoreDirector is moving into the switching
market from its early offerings in long-haul
point-to-point DWDM systems.
The coming year will fall short of all-optical
networking; however, it will be a year when
carriers will be given the tools to get far greater
functionality from DWDM than we have seen
before.
As for the stocks of the companies, our feelings
are more mixed. The dilemma we believe
investors will face in 2000 is looking at a
business environment that is very healthy and
reaching a comfortable conclusion that new
buyers will pay still higher prices for the shares
after the phenomenal moves of 1999. Some
companies will have developments that are
important enough that they will support still
higher prices during 2000. We believe that JDS
Uniphase may end up in that category.
Sycamore Networks, on the other hand, may
knock the cover off the ball in 2000. Yet,
because investors were so generous in what
they were willing to pay for the shares in
advance of the company's real revenue
opportunity in 1999, the company may do well
just to hold its ground from a share-price
perspective over the course of 2000.
We believe the key to successful investing in
the photonics sector in 2000 will be selectivity
and good timing. In most years, the market
gives you a chance to buy the shares of very
good companies at a relatively attractive price.
If we looked back at 1998, the global-liquidity
crisis sent fear through the marketplace and
had an impact on Corning's business. We knew
that Corning would emerge from the crisis in a
strong position, but when fear creeps into a
market, everyone is afraid to fight the trend.
Well, if you fought the trend in the case of
Corning in the late fall of 1998, you may have
tripled your money in the subsequent year.
Investors were not treated to a similar
opportunity in 1999 with the photonics
companies. The year was a one-way ride up,
and while we are not predicting anything as
dramatic as 1998's global-liquidity crisis in
2000, it is an election year and there is no
incumbent we can bet on for a repeat term, so
we have uncertainty. Uncertainty is the enemy
of financial markets, and we would guess that
the presidential election will create periodic
concerns that may give investors an opportunity
to buy shares of the optical component and
system companies at more attractive prices
than exist now.
Keep your eyes on the competition
We mentioned selectivity as another key to
2000. We said during the course of 1999 that
we believed it was too soon to pick winners and
losers in the optical-component sector. We
would argue that during the course of 2000, the
shortage environment that fueled enthusiasm
for any company that sold anything into the
market in 1999 will give way to a
more-competitive environment. It would be
premature to assume that it will be a level of
competition that will create major industry
fallout, but given high valuations in the group,
it will likely create periods of concern for the
affected companies.
We believe, for instance, that the major
impetus for JDS Uniphase stepping beyond its
exclusive joint venture with Optical Coating
Laboratory was to put in place a singular
management focus on solving the shortage of
thin-film-filter-based WDM devices. That
solution might come from greater productivity in
the manufacturing of these devices, but it may
also come from hybrid devices that are a blend
of technologies. For companies like NetOptix
that caught the attention of investors because
they were attempting to address the shortage
of thin-film filters, this situation might set in
motion forces that will say it is not good
enough to be in a thin-film-filter manufacturing
business.
There is another kind of selectivity: focusing on
new technologies. We hear a lot about planar
devices or optical devices that have some
degree of integration as part of their story. This
is just one example. What we believe is that in
2000, investors will be treated to a new crop of
companies that will represent different
opportunities. As 1999 drew to a close,
SoundView had the opportunity to be one of the
underwriters of Finisar's initial public offering.
Finisar brought a completely different
optical-product portfolio aimed at the Gigabit
Ethernet and Fibre Channel markets. We believe
the company's unique profile will be an asset to
the story and the stock in 2000. We also
believe there will be other similarly unique
initial public offerings in 2000.
So will there be an encore? We do not believe
2000 will be a repeat of 1999. It is rare in the
investment business to have repeats of the
kind of year that we witnessed in photonics last
year. Look at Amazon in 1998. It and many of
the other Internet stocks had remarkable years,
just like the photonics sector did in 1999. They
had another remarkable business year in 1999,
but depending on when you bought Amazon's
stock, you could have done as well as doubling
your money and as badly as having it cut in
half. We expect that kind of environment in
2000. |
