Telecoms Are Hurting and Their Suppliers Feel the Pain
By Jerry Knight
Monday, October 30, 2000; Page E01
When the dot-com bubble started to burst early this year, the Wall Street wizards who had been promising that investors could get rich buying stocks of companies doing business over the Internet quickly came up with Plan B.
Don't buy the dot-com stocks, they said. Buy the companies behind the dot-coms, the ones that build the Internet infrastructure, create the Web sites, program the computers and run the server farms that make electronic commerce possible.
The infrastructure companies, Wall Street said wishfully, are the "arms merchants of the Internet" and will prosper even if e-commerce crashes and burns.
That investment strategy worked no longer than the online shopping fad that was being promoted by Wall Street's hula-hoop hucksters at this time last year. (Remember when they were telling us everybody is going to do their Christmas shopping on the Web, and after that nobody will ever go to the mall again?)
E-commerce stocks, of course, dried up along with the Christmas trees, and soon investors were shedding them as fast as a fir flings its needles.
Internet infrastructure stocks were not far behind. By summer it was obvious that the "arms merchant" analogy had been dreamed up by analysts too young to remember what happens to defense plants when peace breaks out.
The lesson--that when an industry goes into a dive its suppliers soon will swoon as well--has been totally lost on Wall Street.
The same blunder is now being made in the telecommunications industry. Telecom stocks are in the tank, but until recently the stocks of telecom equipment makers made up the hottest technology sector of the Nasdaq Stock Market.
The inevitable correction started last week, but the same Wall Street firms that insisted Internet infrastructure stocks were immune to dot-com disease are now proclaiming the invincibility of telecom suppliers.
Don't believe it.
Even after a serious reality check last week cut their prices by 10 percent to 30 percent, the three top telecom equipment companies in Maryland and Virginia remain among the most overpriced stocks a Washington investor can buy.
The shares of Ciena Corp. of Linthicum, Corvis Corp. of Columbia and Optical Cable Corp. of Roanoke are, to use one of Wall Street's most subtle slurs, "priced to perfection."
If the companies can keep growing as fast as they are now for as far into the future as it is possible to foresee, the three stocks may even prove to be bargains at their current prices.
But don't bet on it.
By conventional measures, shares of Ciena, Corvis and Optical Cable are selling at tulip-mania prices.
All three make hardware for fiber-optic communications, which flashes signals down tiny glass strands in the form of pulses of brightly colored light. Optical Cable makes the glass cables themselves. Ciena and Corvis, bitter rivals, make equipment that enables the light waves to go farther, faster, more efficiently.
It is a hot business because fiber-optic lines can carry hundreds of times the signals of copper wires.
Thanks to its technology, Ciena is the biggest company in the nation that makes fiber-optic equipment exclusively. It racked up $233 million in sales in the third quarter of the year.
Corvis, still a start-up, went public only a few months ago and set a record for the most successful public offering ever by a company that had, at that point, yet to take in its first dime of revenue. Since then, it has sold almost $23 million worth of hardware to its first customer.
Optical Cable's business isn't really high-tech at all: It buys glass fiber and spins it into cables in pretty much the same way that John Roebling twisted steel wires into the cables that hold up the Brooklyn Bridge.
Optical Cable is a down-home, downstate Virginia success story. Founder Robert Kopstein saw the fiber-optic bandwagon coming and jumped on early. His company sold almost $8 million worth of cable in August.
In the latest quarter, Optical Cable made $2.3 million (4 cents a share) on revenue of $17 million, a very nice profit margin for a manufacturing business.
Enamored of the stock, investors bid it up to $44 a share earlier this year. Even now, down to $17 as of Friday, Optical Cable carries a market value of close to $1 billion.
A billion dollars is a lot for a company generating profits at a rate of a little better than $10 million a year. It gives Optical Cable stock a price/earnings ratio of 99 to 1. That's five times the P/E of the blue-chip stocks in the Dow Jones industrial average, which is around 20. It's four times the P/E of the Standard & Poor's 500-stock index, which averages 26.
For more perspective, Optical Cable's price/earnings ratio almost matches the 102 P/E of Dulles-based America Online Inc., which is far and away the most successful high-tech company in the Washington region. AOL's long-term growth rate is 44 percent a year, compared with 31 percent for Optical Cable.
But 100 times earnings is a pittance compared with Ciena. At Friday's closing price of $104.38 a share, Ciena stock is selling for 522 times current earnings and 338 times projected profits for the next fiscal year.
Based on data from the Bloomberg database, Ciena looks to be Washington's most pricey and overpriced stock.
As the chart with this story shows, there are a couple of local companies with even higher P/E ratios, but they're special cases. Reston-based InteliData Technologies Corp., which makes electronic payments software, and McLean-based LCC International Inc., which designs telephone systems, are struggling companies, barely profitable. The high P/E is the result of puny profits, not a high stock price. InteliData closed Friday at $5.41 a share, LCC International at $13.19 a share.
There are about a hundred local companies that have no P/E ratio because they have no E.
Corvis is one of those "pre-profit" companies, worth focusing on because it was started by David Huber, the same fiber-optic genius who founded Ciena; is in the same business; and is endorsed by many of the same analysts.
Wall Street's prevailing opinion is that fiber-optic equipment sales will grow rapidly for years to come and fiber-optic stocks will keep going up.
The first doubts about that forecast surfaced last week. Nortel Networks Corp., the Canadian company that is the biggest telecom hardware maker, reported its fiber-optic equipment sales did not grow 15 percent over the previous quarter as had been expected. In fact, they slipped a little bit.
The stock of every company in the industry plunged Wednesday when that shortfall was revealed. The stocks rebounded on Friday, cheered on by analysts for the majority of big Wall Street firms. The phrase "buying opportunity" turned up in one press release after another.
The cheerleaders said little about the dot-com-style debacle facing the telecommunications companies that are big buyers of fiber-optic equipment.
Telecom companies are beginning to die from overpopulation.
Like algae in a pond, telecom carriers bloomed because they were over-fertilized with cash over the last couple of years. They built way more miles of fiber-optic networks than there is any need for right now. They can't sell their services for anything close to the prices they were counting on. They're choking: Without customers to pump in money like oxygen, telecom stocks could deteriorate into pond scum.
Local companies are good examples of what's happened to the whole industry: PSINet Inc. of Herndon is down from $60 a share to $6.22; E.Spire Communications Inc., also of Herndon, is down from $16 to $2.53; Global TeleSystems Inc. of Arlington, is down from $35 to $2.06.
Nettel Communications, a Washington telecom backed by some of the same investors as Global TeleSystems, filed for bankruptcy two weeks ago, and both Global and E.Spire are considered bankruptcy candidates.
When telecoms die, their suppliers feel the pain. Ciena has already lost one customer, Iaxis Ltd., a British firm that stuck Ciena with an unpaid bill for $28.2 million. Global TeleSystems is also a big Ciena customer.
Not to worry, says Wall Street. Why shouldn't investors believe them?
Take a look at the list of local stocks with the highest price/earnings ratios. Proxicom Inc. and Cysive Inc.--both Reston-based "Internet arms merchants"--are still on the list with P/E ratios of around 66.
That's high enough to be scary, but last spring their ratios were way up in the triple digits, close to where Ciena is today. Proxicom stock was $62 a share then; today it's $11.94. Cysive was a $61.50 stock then; today it's $7.25.
The same analysts who were telling investors to buy those stocks last winter, when they were in the 60s, are still pushing them today, when they've been marked down 80 percent and 90 percent.
Those are Wall Street wizards who said Internet infrastructure stocks would not be hurt by the dot-com disaster. And they work for the same investment firms that are saying the telecom equipment makers will walk away unscathed from the telecom crash.
Jerry Knight writes a daily stocks roundup after the markets close on washingtonpost.com. His e-mail address is knightj@washpost.com.
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