The Royal Rumble LU vs. NT thread
Communications' Biggest Bottleneck
By Kevin Petrie
Staff Reporter
03/15/99 11:12 AM ET
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 most scarce 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.
There are hardly any entrepreneurs trying to break in to 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. |
