Thread:
Regarding one of my W&W portfolio members:
Faster is better. That's why fiber-optic networks, brimming with
rivers of email messages and Web pages, are looking for ways
to squeeze out more bandwidth. Companies such as Ciena
(CIEN:Nasdaq), Alcatel (ALA:NYSE) and Lucent (LU:NYSE)
are working on a number of products to pack more light waves
into each optical fiber.
The result is a backlog of orders for the optical components
built by Uniphase (UNPH:Nasdaq), its merger partner JDS
Fitel (JDS:Toronto), SDL (SDLI:Nasdaq) and E-Tek
(ETEK:Nasdaq). Their arcane pump lasers, filters and
amplifiers are the scarcest technology in the communications
business.
"We're ramping manufacturing as hard as we can, but at the
same time demand continues to grow," says Kevin Kalkhoven,
CEO of Uniphase, a leading builder of several components
based in San Jose, Calif. "That's our biggest challenge right
now," echoes Donald Scifres, CEO of SDL, a maker of pump
lasers based in San Jose, Calif.
Both Uniphase and SDL have more than doubled their unit
output in the last year.
The stocks are breathing some rarefied air on Wall Street.
Uniphase shares cracked 100 Thursday, then settled to 99 7/8
at Friday's close. Uniphase has gained roughly 200% since
October and increased by more than 10 times since 1995. Its
merger partner, JDS Fitel, has quadrupled since October on
the Toronto exchange. SDL has more than quintupled since
October and added 2 1/16 to end at 65 3/4 Friday.
Analyst Raj Srikanth with First Albany predicts that sales of
optical components will jump from $1.8 billion in 1998 to $3.5
billion by 2000. Some component suppliers have seen their
shares hop by as much as 1,000% in the past three years.
The stocks' popularity seems unlikely to ease before the
demand for components does.
Uniphase trades at 100 times last year's profits, excluding
merger and acquisition charges. SDL is trading at 75 times
operating earnings, while the recent IPO highflier E-Tek is
trading at 98 times earnings. What helps is that Uniphase is
expected to grow profits 40% in coming years and E-Tek 28%.
Cisco (CSCO:Nasdaq), which is valued at 78 times operating
profits, is expected to grow earnings 30% a year.
Research director Charles McCurdy with Veredus Asset
Management, four-year owner of Uniphase, isn't selling yet.
His firm snapped up a little E-Tek to diversify. "I think that
there's enough demand right now to keep everybody's plate
full."
The challenge is to expand facilities without disrupting
production. "It's akin to building a new airport, while at the
same time keeping the old airport functioning," says Bill
Diamond, marketing vice president with E-Tek, a peer of
Uniphase that also is based in San Jose.
It's the right problem to have. Component companies are
feeding a ravenous market demand that would make even
Cisco envious. To maintain its 40% sales growth in 2000 and
beyond, Cisco must convince telephone carriers to replace
their voice switches with Internet systems. For now at least,
Uniphase's growth rate depends simply on how fast it can
expand its facilities.
That's not easy. The optical chips use four different elements --
not just silicon -- and the testing process can last six months
or more. The technical expertise of these companies, which
involves cramming more and more functions onto chips, is
bringing out some interesting comparisons.
"Like Intel (INTC:Nasdaq) with the Pentium chip, Uniphase will
increase its power and its reliability," says Phil Lamoreaux
with money manager Lamoreaux Partners, which has owned
Uniphase since its IPO in 1993.
"Moore's Law is being broken in the optical world," Lamoreaux
says. "We are more than doubling capacity every 18 months."
Intel's co-founder Gordon Moore predicted that the number of
transistors that could be crammed onto a microchip would
double at a regular interval -- roughly 18 months.
Lamoreaux should know. As an analyst with American
Express, he put venture-capital funding into Intel in 1970. Intel
began to dominate the microprocessor market and was able to
increase its price relative to chip performance for years.
Similarly, Lamoreaux predicts, Uniphase will be able to charge
a premium for its optical amplifiers and other components.
But not yet. Last year, a price war amongst customers such
as Ciena and Lucent created a ripple effect. Including an
accounting charge for disposal of assets, Uniphase gross
margins declined to 47% from 49% a year earlier. E-Tek gross
margins, on the other hand, slipped to 51% in the December
quarter from 56% one year earlier.
One latecomer to the game stumbled. Ortel (ORTL:Nasdaq),
an optical components company based in Alhambra, Calif.,
came up against stiff competition from Uniphase in selling its
pump lasers, which go into certain amplifiers. Ortel ditched the
products in November, deciding that further R&D wasn't worth
the cost. The stock has sagged from 20 last summer to 7 1/2
Friday as sales of its other products slowed as well.
The next generation of optical technology will kick up demand
for components further. Sycamore Networks, a promising
startup based in Chelmsford, Mass., is starved for its optical
switch components. "One of the things we bet on was that we
would be able to get whatever components we wanted," says
founder Daniel Smith.
Most of the current venture-capital investment is guided to
optical networking startups like Sycamore Networks that are
customers of E-Tek and Uniphase. Hardly any entrepreneurs
are trying to break into the fiber components business. Lucent
only makes some of its own components, but these are for its
own consumption.
Consolidation among the top players is already on the way.
This spring, Uniphase, the acquisitive leader in this field, will
complete its merger with Ontario-based JDS Fitel. Srikanth
with First Albany says E-Tek, SDL and others might have to
follow suit in coming years.
"It comes down to us three or five companies," says E-Tek's
Diamond. |
