here's the full text of that 21st Century write-up from the previous post. for the file.
Here's a way to get in on super-hot optical IPO's before they happen!
Optical networking is hot. Just as we predicted last month, optical stocks are leading this market out of the nine-month cycle bottom. And they're leading quickly.
Sycamore (SCMR), JDS Uniphase (JDSU) and Nortel Networks (NT) were up 36%, 32%, and 15% for the week ending June 2nd. Even struggling Lucent (LU) tacked on 10 points. Those are spectacular gains, every bit equaling the harrowing falls that we've seen over the past two months. Which brings up a good point: in a perverse way, there is a good side to the hyper-volatility that can lead to a stock falling over 50% in just a few months. Any company that has that ability also has the ability to go up again -- and much further -- just as quickly. Especially the optical companies.
Another trend that continued last week was the incredible valuations given to optical networking startups -- both in public market IPO's, and in private market transactions. ONI Systems (ONIS) went public and was granted a $10 billion valuation by investors. Chromatis Networks was bought outright by Lucent for $4.8 billion. Both these companies are essentially still development stage optical startups -- yet they've achieved amazing valuations already.
As long as the action is this frothy, we want to play it for all its worth.
Which leads us to MRV Communications (Nasdaq: MRVC), definitely the most interesting speculative optical play out there right now. MRV is a fiber optic components company that decided a few years ago to fund and nurture start-ups across all sectors of optical networking. They've also been aggressive about buying up strategic optical companies around the world. Tote up their portfolio, and you've got a potentially lucrative collection of optical assets.
All told, there are 14 different companies in the MRV group. And some of these are very hot names, with a lot of buzz. We think many of the companies in their group can be spun out with successful IPO's, quickly achieving market caps in the billions. Which would be very, very good for shareholders of MRV, because right now the parent company's total market cap is only $2 billion. For perspective, their 23% stake in white hot optical networking start-up Zaffire (not yet public) could easily end up being worth more than $2 billion all by itself.
So there is very compelling upside to MRV, provided that you believe in the speculative "incubator" business model. We are definitely believers in this model, because of our experience with Softbank (9984 - Tokyo; US OTC - SFTBF) and also Safeguard Scientifics (SFE) -- two similar business plans. It's always nice to get in on venture capital in the earliest stages, and MRV is a way to capture a lot of the explosive upside in pre-IPO optical networking startups. In fact, it's just about the only way to do it.
Could MRV be the next Softbank or Safeguard? We sure think so.
With MRV, you don't just have to take our word for it. Another big believer in MRV is the super-heavyweight champion of the mutual fund industry: Fidelity Investments. According to the latest SEC filings, Fidelity owns about 6.8 million shares of MRV, over 12% of the company. That's a big position, even for Fidelity. Now, we'll admit that we like to ride the coattails of a Fidelity or a Janus to some degree when it comes to due diligence on a more speculative investment. They have the heft and the research staff to really go over a company with a fine-toothed comb, and seeing this huge stake provides a nice measure of comfort.
The clincher on MRV is that they are cheap now after the correction. This stock had a wild run-up in January, all the way to a (split-adjusted) $97. With the incredible sentiment driven volatility right now in optical stocks -- both up and down -- then MRV could move back up, and move quickly. Indeed, MRV could move up, up, and away after a few successful spinouts, and a little more visibility with Wall Street.
There is the potential for five of their companies to be spun out in IPO's by the end of this year or first quarter of next year. So we won't have to wait long to see if this investment is going to pay off. And if you want to stick around for the long haul, then you've got massive upside if MRV's group of companies progresses to maturity. There could be billions of dollars of stock market wealth created by this group.
MRV is not just a venture play
MRV is one of the world's largest manufacturers of optical components in its own right, in addition to its venture activities. With their recent acquisition of Chinese passive component manufacturer Fiber Optic Communications Inc. (known as FOCI), MRV is now the only optical manufacturer besides JDS Uniphase with a presence in both active and passive components. It also puts them among the top merchant component makers, an area experiencing incredible demand where every manufacturer can easily sell everything they can make. (See last month's issue for more on optical component makers). FOCI is a key acquisition, because they come with a 150,000 square foot manufacturing facility in China that's already up and running. Manufacturing ability is the key to success right now.
MRV's just announced plans to formally join their Optical Access division with FOCI and two other recent acquisitions, and spin the company out under the name Luminent, Inc. The other companies besides FOCI going into Luminent are two Taiwanese companies: Optronics International, a laser diode and transceiver maker, and Quantum Optech, which makes optical coatings.
These acquisitions are also critical for another reason, and it's the same reason we're so high on JDS Uniphase's ability to command more and more market share down the road. It's much more cost effective to make integrated modules for optical components. A manufacturer needs to have all the elements bundled together. MRV can do that now following these acquisitions, and nobody else besides JDSU has this ability.
Revenues at MRV's optical access division came in at $65 million last quarter, without these acquisitions factored in. It's a big, growing business, although it didn't show any year over year growth due to a strategic decision to exit the LAN switch business. That's also been keeping the share price down, which isn't necessarily a bad thing for us, coming into the stock now after the correction.
And while Luminent is nice, and could get a sweet valuation on the spinout -- it's not the thing that's got us excited about MRV's potential. We like their start-up portfolio, and their recent acquisition of an Israeli company called Jolt.
A multi-billion dollar portfolio of optical companies
On the latest quarterly conference call, CEO Noam Latan gave details on MRV's holdings, which look like this:
Development Stage Enterprises:
Zaffire (ownership stake -- 23%): metro optical networking
Zuma Network (90%): network supercomputer switch routers
Charlotte's Web (53%): terabit routers
Hyperchannel (42%): b-to-b e-commerce
All Optical (50%): unannounced
Optical Crossing (60%): optical switches
Operating Entities:
Luminent (100%): optical components and subsystems
NBase-Xyplex (97%): networking equipment
RedC Optical (35%): optical modules
In addition to these, there was the recent acquisition of Jolt, an Israeli company that's working in the "wireless fiber" area, going head-to-head with celebrated startups TeraBeam (partnered with Lucent) and Air Fiber (partnered with Nortel). This is an area that's already creating an investor frenzy -- even though there aren't any public companies to invest in yet (MRV is the closest thing to a pure play on wireless, optical last mile connectivity, until they spin out Jolt).
This is a stellar portfolio. There is an incredible amount of latent value here, judging by recent valuations given to companies like Chromatis, Xros, Cerent, Siara, and a host of other optical startups. In fact, one of the few analysts that covers MRV toted up MRV's stake in these companies and came up with 12 to 18 month price target of $157. Right now the stock's at $35 and climbing. We think his estimate is going to end up being conservative, once the IPO's start flying out of the gate. We haven't been this excited working the numbers since we ran through Softbank's holdings in February 1999.
The companies that have us really pumped up are Zaffire, Jolt, and Charlotte's Web. Although there's also great potential for Luminent to be very valuable, and RedC Optical is moving into the subscriber management space that's dominated by Redback. This portfolio is a potential treasure trove of riches!
Let's look at Zaffire. This a company that was founded by the son of MRV's Chairman with an initial investment from MRV. Subsequent investors have been legendary venture capital firm Kleiner Perkins, as well as super-hot router company Juniper Networks (JNPR). Zaffire's credentials so far are impeccable, and they have a strong management team (no doubt lured by the promises of quick millions) but more importantly, their products are attracting a lot of industry attention.
It's a well-known forecast among optical mavens that so-called "metropolitan optical networking" represents one of the biggest market opportunities out there. So far, nothing's really been done to bring fiber into high-density metropolitan area. But this is the next logical extension of fiber -- from the backbone right into downtown areas. The word is that Zaffire's metro products, which are not "vaporware" but are in actual testing at this point with Williams Communications and Broadband Office (admittedly, these companies are also investors) -- are very hot. The buzz on Zaffire's Z3000 is that it could be a huge breakthrough for metro and regional markets, because it scales rapidly, and it's got a cheaper "per port" cost than current offerings. It also has a small "footprint" and uses less power, which is an important consideration in overcrowded telco central offices.
The potential of its end markets, coupled with the wide open playing field, could give Zaffire a gigantic valuation, probably between $8 to $10 billion in a favorable IPO climate. That could make MRV's 23% stake worth about $2 billion. And if there stuff shows real promise, it's likely that one of the "big boys" like Cisco, Lucent, Nortel or Alcatel will want to swoop in to buy them. Cisco's proven that they are willing to pay up to buy optical technology, even after the target company has gone public. They recently bought Arrowpoint for $5.7 billion only one month after they went public -- Cisco's playing catch-up in optical, so they are on a buying spree. It's inflating prices in this whole sector.
MRV's Jolt could be the "next big thing"
According to an interview with Jolt's CEO and founder, Dr. David Medved, MRV may have just pulled off the ultimate steal when they bought this company. In fact, he said that if a pending patent application by Jolt is granted, then " we should have sold the company for a few trillion dollars". (He was only partly kidding).
What he's talking about is that Jolt has developed a unique system to perform wireless communications without electronics. They are able to project photons through the air, and pick them up a kilometer away -- without converting the signal to electrons on either end. They're transmitting photons without conversion. That's never been done, and according to Medved, the product's close to being a commercial first. Right now they've demonstrated it only in the lab, and in the field.
This would be one of the "holy grails" of optical networking, as the myriad conversions from electronic to optical signals make for the biggest bottlenecks in optical networks. We don't know how much of this talk from Medved is showmanship, but if he's really able to transmit photons, then we could be on to something very, very big. He says they will be introducing a product within 6 to 12 months.
If this patent is granted, and it works -- big "if's", mind you -- then Jolt's technology could become a key enabler of any all-optical wireless network. We'll keep a close eye on this patent and this product, and we're going to get more details on this at the upcoming Supercomm 2000 event, where Jolt is giving a presentation. So stay tuned.
Charlotte's Web, their other potential high-flyer, is developing a Terabit Router (a really, really fast router) for the Internet core, an area completely dominated by Cisco and Juniper right now. Their product is a terabit router with a twist, in that it's also backward compatible with legacy voice applications, giving guaranteed levels of quality. This is a big deal because it means that their router can be used to carry voice and video without quality loss. It won't be a purely data router, and it could conceivably capture market share quickly as an integrated routing platform for voice, data, and video.
Okay, we think you get the picture on the potential here at MRV. But don't think for a second that this is anything other than a speculative, "swing for the fences" type investment. There are still many, many execution risks to overcome before these products, and start-up companies, start to pay off big. Yet the "big boys" of networking have proven that they are willing to pay billions to lock up these types of companies early. We think that continues, and that MRV's portfolio is worth a ton of dough.
We hate to jinx it, but MRV could end up being the next JDS Uniphase. Yep, there could be 10x in this stock over the next two years. But remember, you have to live with volatility, and if it goes down -- it doesn't necessarily mean there's something wrong! It just means it's volatile, and the market's having a hard time placing a value on these assets. It will always be subject to violent investor mood swings, both down and up. If you can live with that, then go for it -- because there's lots of "up" room in MRV. |
