A new way to play the optical-network boom
Companies like Digital Lightwave, Newport, Tektronix, Agilent and Keithley test the fiber-optic networks that other companies build, and these days, they can't seem to grow fast enough.
moneycentral.msn.com
By Barbara Grady
Testing...one, two, three. Testing.
Ready for the next wave of fiber-optic plays? Then put down your shares of optical component makers JDS Uniphase (JDSU, news, msgs) and SDL (SDLI, news, msgs) after their 400%-plus performances over the past year, and take a look at the companies that ensure their products actually work.
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That would be the job of the makers of optical test and measurement devices -- little-known folks Digital Lightwave (DIGL, news, msgs), Newport (NEWP, news, msgs), Tektronix (TEK, news, msgs), Agilent Technologies (A, news, msgs) and Keithley Instruments (KEI, news, msgs). The shares of the first three have jumped 1,280%, 613% and 570% over the past year, so they're not too obscure. But it's fair to say that most mainstream tech investors have not yet caught up with the growth potential in this somewhat unsexy field.
"I certainly know investors are scouring the marketplace looking for plays in the optical components market. Look where Digital Lightwave has been," says Kevin Slocum, an analyst for of Wit Soundview. "But is the opportunity over? Far from it. We have a long way to go."
Optical testing and monitoring equipment is a key enabler to the optical communications revolution. Aberdeen Group, a consulting firm, forecasts the optical-network market will grow 51% annually for the next three years to reach $17.7 billion by 2003. Meanwhile, RHK -- the telecom industry's main forecasting firm -- predicts that the market for the components used to make optical networks should grow from $6 billion today to $23 billion by 2003 and $30 billion by 2004.
The punch line: RHK analyst and survey author Jay Liebowitz says the market for optical test equipment should grow at least as fast as the component market. "We see component manufacturers adding tremendous amounts of capacity, which means that they need comparable amounts of test equipment to test all the components they plan to ship, as well as test equipment to develop new products," Liebowitz says.
Tremendous revenues expected
Where does that leave investors? Slocum believes that if the worldwide optical components market is to grow fourfold in three years, to $23 billion, "then we certainly are going to have a more substantial revenue stream from the companies making systems that test them than the couple of hundred million associated with those names now." That means he sees tremendous revenues ahead for Digital Lightwave, Newport, Keithley, Tektronix and Agilent.
Slocum rates Digital Lightwave a "strong buy" and Newport a "buy," "although it's the best plain 'buy' rating I've ever had." He compares Newport's role in providing test-and-measurement equipment to optical-network equipment manufacturers to the role Applied Materials (AMAT, news, msgs) has played in the success of semiconductor manufacturers. Applied stock has supplied annualized returns of 64% for each of the past five years, as the role of semiconductors in our society has exploded.
The role and deployment of optical networks in our society is just beginning. Executives from Agilent, Textronix, Keithley and Digital Lightwave describe the market as in its infancy, but with demand so strong their only challenge is keeping up.
"You will need tools for installation and deployment of the fiber-optic equipment and then, when those networks are in place, there's a significant market for ongoing maintenance and monitoring of those networks," said Digital Lightwave Chief Executive Officer Gerry Chastelet in an interview.
Chastelet forecast 25% yearly growth for the optical-network test market. But analysts call that too conservative, since Digital Lightwave's revenues are currently growing at 129% a year. And other test device makers, even the large ones, posted communications test revenue growth of 40% and above. Newport's sales to the fiber-optic communications market grew 201%.
Digital Lightwave is the purest play
Digital Lightwave is regarded as the purest play in the optical-network test market because it makes nothing else. One of its two product lines features its Network Information Computers, portable handheld devices that field operators use to test performance of a network. It recently introduced one to test dense wave division multiplexing systems (DWDM), the mother lode of all optical networking. The second product is the Network Access Agent, which is used for centralized monitoring and analysis of broadband networks.
Digital Lightwave is the only optical test company that makes a portable product for field inspection of these networks. That has won it a customer list that reads like a who's who in networks -- Ameritech, Cisco Systems (CSCO, news, msgs), GTE (GTE, news, msgs), Level 3 Communications (LVLT, news, msgs), Lucent Technologies (LU, news, msgs), WorldCom (WCOM, news, msgs), Nortel Networks (NT, news, msgs) and Qwest Communications (Q, news, msgs).
Products being snatched up
But all the optical test makers enjoy fairly star-studded customer lists. That is because most equipment suppliers are racing to answer surging demand from network operators, who in turn are racing to answer demand for bandwidth. The equipment suppliers and network operators will take supply from wherever they can get it.
That bandwidth demand is being answered by DWDM, a relatively new optical technology. DWDM network systems assign data to different wavelengths of light on a single line, allowing 80 or more signals to travel on one strand of fiber. The optical-network manufacturers are focused on DWDM, and all the test-device makers are developing and selling products to test these new systems. RHK researchers predict growth in the market for DWDM equipment will be 50% annually for the next several years.
Tektronix, whose stock is up 89% in the last year, recently spun off businesses that were not in test and measurement. Its executives say orders for communications test equipment rose 60% in its last reported quarter from a year earlier. "DWDM optical-networks equipment is one of the markets we focus on," says Scott Bausback, general manager of the Tektronix Communications Business Unit.
Technology means more flexibility
Agilent, the former Hewlett-Packard test and measurement division that did an initial public offering in November at half its current price, pointedly touted the success of its communications test business to Wall Street after its first quarter. It is also focusing on DWDM products in its communications test area. "Dense wave division multiplexing created a whole new wave of products and flexibility," says Carla Feldman, Agilent Technologies' marketing manager for Lightwave products.
The flexibility is that photonic signals don't care what the underlying electronic protocols are. That means the former debate about whether SONET (synchronous optical network technology) or ATM (asynchronous transfer mode) or Frame Relay is best is moot. "Optics bring a transparency to the network, moving data independent of whether it is IP or a SONET network or whatever." The result, she says, is a "tremendous drive" by carriers to put DWDM in place.
But the surge of demand that manufacturers cite has its dark side, too -- a shortage of capacity. It's a side that might lead investors to question the valuation of these optical test stocks.
Can't match the demand
Optical-network component makers can't keep up with demand, and at the moment there's a worldwide shortage of some components. Feldman says that creates a huge opportunity for test and measurement people, because they are offering ways to automate production to make it faster.
Slocum fears that progress isn't happening fast enough. "We are not going to get as big as $30 billion in optical components unless we have substantial amount of supporting infrastructure in tests and whatever," he says. "Today it is assembled in a manual fashion, and yields are low."
Aberdeen Group analyst Andrew McCormick says neither the component makers nor the test companies are keeping up with the challenge. "The ramp time for optical equipment is not up to demand. There are a lot of companies in beta test stage. I don't know how they are going to go into full-stage production. A lot of these guys are startups, and they are outsourcing their production," McCormick says. "For them to start manufacturing this stuff en masse is going to be a challenge."
If a few of these firms stumble out of the gate, it may only be a result of component and manpower shortages. So it sounds like investors who have been late to this party might get better prices fairly soon at which to initiate positions.
At the time of publication, Barbara Grady did not own or control shares of any of the equities mentioned in this column. |
