Interesting analysis--bullish on NT.
stockhouse.com
September 6, 2000
StockHouse News Desk
By Hilary Chiba (hchiba@stockhouse.com)
Fiber Optics: Tech Analyst Reveals Ways to Play Two Hottest Trends
Miami, FL, September 6 /SHfn/ -- Fiber optics are pushing the limits of communications on a daily basis. And keen investors aren't willing to let the hottest new market sector pass them by. That's why StockHouse sought a follow-up interview with the tech analyst who alerted readers to a resurgence in chip stocks days ahead of the rest of the Street. In another exclusive interview, portfolio manager Dan Morgan of Noble Financial Group identifies the two hottest fiber-optic technologies, and ways to play this sizzling sector.
Morgan opts to get exposure by purchasing stock of companies that already have dominant positions in other sectors.
Morgan calls dense wavelength division multiplexing (DWDM) the hottest thing in fiber optics. DWDM is instrumental to data transmission because it increases network capacity by allowing multiple wavelengths to be carried on a single fiber. According to Morgan's research, this technology will allow a carrier to multiply the capacity of its networks by more than a hundredfold without laying additional fiber. Pioneer Consulting expects the global market for DWDM systems to surge to $17.9 billion in 2004, from $4.47 billion this year.
Heavy demand is drawing new entrants like JDS Uniphase [JDSU] and ADC Telecom [ADCT] into DWDM. They will face off with the dominant players Alcatel [ALA], Cisco [CSCO], Ericsson [ERICY], Ciena [CIEN] and Lucent [LU]. In this increasingly crowded field, market leader Nortel [NT] is Morgan's top pick. "Though Nortel has about 33% market share overall, they have about 85-90% of the 10-gigabit market," he points out. Morgan explains that 10-gigabit per second (Gb/s) transmission over 80 channels is really the standard now. That translates into the ability to transmit 10 billion bits of data a second. "And on the 80-channel market," he continues, "they pretty much own the market." Sneak peeks from the DWDM leaders foreshadow a movement toward 40 Gb/s and up to 160 or more channels. Look for Alcatel to roll out a 40 Gb/s system by mid 2001, and for Nortel to unveil an 80 Gb/s system by the third quarter of 2001. A 160-channel system is said to be forthcoming from Nortel and Corning [GLW], but no time guidance has been given yet from either company.
Morgan likes JDSU in particular, because he says its aggressive acquisition strategy will likely help the company corner the market.
Morgan takes a neutral stance on Ciena, a multiplexing-systems firm that has seen its stock price surge 25% since releasing strong third-quarter numbers on August 18. Although Ciena appears to be on track after a major slip derailed the company a year ago, Morgan moves contrary to the Street consensus and remains cautious. "They've been somewhat slow to keep pace with Nortel. And I think Nortel is also pushing the market on a dollar perspective," he says. Nortel's fiber-optic data transmission business did roughly 10 times more in revenue in 1999 than did Ciena's--$4.95 billion versus $482.1 million. From a competitive standpoint that translates into a healthy research and development budget for Nortel.
Another area that is set to explode, according to Morgan, is optical-circuits technology. These high-tech components integrate many light-processing functions onto a single silicon chip. Morgan believes that the chips will prompt the next big breakthrough, which will eliminate electrical interface routers on long-haul applications. Electrical interfaces are required at various intervals on a backbone to regenerate light pulses that deteriorate over distance. The elimination of those interfaces could result in equipment savings of as much as 80%, according to Morgan's research.
At this time, there are a handful of pure plays in this arena. Morgan notes that Bookham Technology [BKHM] and Lumenon Innovative Lightwave Technology [LUMM] may be of interest to the aggressive investor. But he is averse to the risk inherent in many optical startup companies. Morgan opts to get exposure by purchasing stock of companies that already have dominant positions in other sectors, such as Broadcom [BRCM] and Analog Devices [ADI]. Broadcom is a leader in the chips used for set-top boxes, and the company is rapidly making acquisitions. Broadcom recently rounded out its portfolio with the acquisiton of NewPort Communications, an optical communications chipmaker. ADI is a leading manufacturer of digital signal processors (DSPs), and has plans to acquire optical-device specialist BCO Technologies.
Rapid rollouts of new fiber systems keep optical components manufacturers hopping. The components category is broad, and includes lasers, gratings, filters, attenuators, amplifiers, splitters and much more. Technological development calls for a seemingly endless stream of new components, at the expense of manufacturing efficiency. That translates into high component costs, and a backlog of orders from builders like Nortel and Lucent.
That bodes well for optical component makers. Consolidation is sweeping the highly fragmented industry, and should promote efficiency and help retain customers. Morgan likes JDSU in particular, because he says its aggressive acquisition strategy will likely help the company corner the market. JDSU's most notable acquisitions were competitors E-Tek Dynamics and SDL [SDLI] in stock-swap deals. That leaves few independents out in the field, says Morgan. Thankfully for JDSU, the components shortage has not prompted Nortel or Lucent to create their own components. Together, the two comprise roughly 40% of JDSU's sales, so a loss of that business could be potentially devastating. Non-pure-play component makers Morgan recommends include ADC Telecom and Corning.
Volatility will afford reasonable entry points in the days, weeks and months to come.
Optical switching has also seen remarkable growth. The switches patch together wavelengths of light in a fiber backbone. Morgan likes Cisco Systems [CSCO], and he highlights Sycamore Networks [SCMR] and Juniper Networks [JNPR] for aggressive investors. Sycamore and Juniper trade at multiples of 400-500 times forward earnings projections. Cisco is as a more conservative way to find exposure to optical switches. The stock trades at roughly 70 times projected sales.
Industry projections show that there is plenty of excitement left in the space. Exponential growth in Internet traffic has driven service providers to pour cash into infrastructure. WR Hambrecht & Co. reports that spending on broadband equipment reached $73.2 billion in 1999, a 30% increase over the prior year. This year, capital outlays are expected to be more than double 1998 levels, and are estimated to reach $87.7 billion.
The market has recognized that service providers are boosting network capacity to handle more voice, video and data transmission. That's precisely why Morgan's top picks are already highly valued. But traders, take heart--volatility will afford reasonable entry points in the days, weeks and months to come. And presumably, by holding the major players and industry drivers, investors will see years of fiber-optic sizzle.
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