Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: tekboy who wrote (28973)	7/27/2000 12:59:02 AM
From: tekboy	Read Replies (1) \| Respond to of 54805

Missing Photonics Revolution Section--Chapter IV for 1-3, see here: Message 13897280 for 5, see here: Message 14114642 Photonic Revolution IV: Components 11-Jul-00 02:01 ET [BRIEFING.COM - Gregory A. Jones] Coincidentally, we had planned to write part IV of our photonics series this week on optical components. With Monday's blockbuster JDS Uniphase (JDSU)/SDL (SDLI) merger announcement, this segment is now particularly timely. With this look at optical components as well as transmission equipment, we remain primarily in the core of the network, though many of these components function at all points of the optical network. Having already discussed the key technology behind massive fiber bandwidth -- DWDM -- and the difficulties of directing that volume of bandwidth in our recent look at optical switches, we are now going to get a bit more micro instead of macro -- how exactly is that photonic signal created, sustained, and delivered. This is the business of transmitting photons. There are many issues to address in getting a photon from point A to point B. There must be a laser to generate the light signal. There are erbium-doped fiber and Raman amplifiers -- two complementary technologies for extending the distance that a light signal can travel without needing to be regenerated (which involves the expensive conversion of an optical signal to electrical and back to optical). There are pump lasers that provide the power for amplifiers. There are attenuators to adjust the strength of optical signals. There are multiplexers that generate separate signals on the different wavelengths within a strand of fiber (in a DWDM system). There are filters that allow certain light signals to pass while reflecting unwanted signals. There are dispersion compensators that correct for the different speeds at which signals travel on different wavelengths. There are demultiplexers to sort out the many optical signals on the various wavelengths. All of these components are very expensive and absolutely necessary. And they are not low technology commodity items. That is why the market is placing such staggering valuations on the stocks of optical component companies (more on this later). The list above is actually abbreviated, and we cannot possibly go into the specifics of every optical component without boring ourselves and our readers to death. Instead, we can focus on one component that can reduce the demand for most of the other components -- optical amplifiers. An amplifier actually actually consists of sub-products including laser pump modules and optical couplers. Some companies, such as SDL (SDLI), produce both individual components for sale as well as the full amplifier. Amplification technology is in the midst of a revolution. Several companies are now in field trials with amplifiers using a combination of traditional erbium-doped fiber amplifiers (EDFA) and Raman amplifiers. Without going into the details of how Raman improves amplifications, suffice it to say that companies are now having success amplifying optical signals that can travel in the range of 4,000 km without regeneration -- a massive tenfold improvement on existing technology. SDLI is producing some of the leading technology behind this revolution. Companies such as Qtera (recently acquired by NT), Corvis (awaiting its IPO), Alcatel (ALA), and Sycamore (SCMR) are manufacturing and selling the transmission systems that make this technology commercially available to telecom carriers. Why is this a big deal, you ask? Because regeneration is extremely expensive. Unlike amplification, regeneration does involve converting an optical signal to electrical and then back to optical. That final conversion back to optical necessitates lasers for each wavelength in a DWDM system -- a costly proposition. In addition to the equipment expense, there is also the expense of maintaining a network of regenerators every 400-600 km as opposed to every 3,000-4,000 km. It becomes obvious why a company such as Qwest (Q) has already announced a large order for this new technology from Nortel's (NT) recently acquired Qtera division. In addition to optical amplification, the other key area to watch is multiplexing/demultiplexing. Companies such as Avanex (AVNX) are improving this technology so that more wavelengths can be delivered on a single optical strand. Multiplying the number of wavelengths in DWDM systems is a critical factor behind the boom in bandwidth. The Companies Much has changed in the optical component sector for investors in the past few months. Having just closed its acquisition of ETEK Dynamics, market leader JDS Uniphase has now announced its intention to acquire SDLI. This combination would amass a great deal of power in one company, but it does have a chance to get by regulators. Because there are few pure plays in the optical component space, the potential unification of three pure plays just this year -- JDSU, SDLI, and ETEK -- appears on the surface to be an unfathomable concentration of market power. But we must keep in mind that this company does have formidable competitors: Nortel, Lucent (LU), Alcatel (ALA), Corning (GLW), and Fujistu are among the major players in this industry. And upstarts Avanex and New Focus (NUFO) are also offering JDSU serious competition. There are some overlapping product lines between JDSU and SDLI, and it should be expected that this merger will not go through without some concessions. But the key for JDSU is that it can combine its strength in passive optical components with SDLI's strength in the key EDFA and Raman amplifier space that is so critical to the future of the optical network, and it is a better than even-odds bet that this will happen. Valuations The only remaining question is the valuations. JDSU's acquisition price for SDLI was $41 bln in stock for a company with $72 mln in revenues last quarter. That's not earnings, that's revenues. Insane? Probably not. Excessive? In the short run, it may appear that way. JDSU is paying over 200 times next year's earnings for SDLI. As with many optical companies, the truth is not that extreme -- SDLI will almost certainly exceed estimates of $1.62 next year, particularly if it is part of a combined JDSU/ETEK. But even if it makes $3 next year and $6 the year after that, this would still represent a P/E of over 50 on FY02 earnings. But here's why we still like the prospects for a combined JDSU/SDLI even if the market is rough on JDSU in the short-run: this company will be a dominant player with a massive patent portfolio in an exploding sector. Its future is not guaranteed, particularly given the integration issues that lie ahead. But like Cisco, JDSU is a company that has excelled in the area of acquisitions. If it gets this deal past the DOJ, it could enjoy many quarters of better than expected revenue and earnings growth. And also like Cisco, explosive growth and the ability to deliver to Wall Street every quarter will be awarded with consistently high valuations. Other pure plays such as Avanex and New Focus also enjoy extreme valuations, but a combined JDSU/SDLI will offer a much broader product portfolio. And as we have consistently argued in this series, those that offer strong technology and an end-to-end solution will be the winners. JDSU is in a position to do both. (If you like the series, sign up for free trial at www.briefing.com)