NBMO sector report from 3/31: ADSL BEGINNING TO GAIN MOMENTUM: IMPLICATIONS FOR OUR STOCKS.
- RBOCs are beginning to feel pressure from competitive access providers
- CLECs have seen significant increases in funding recently -- should benefit Cisco.
- Cable modems have been also been picking up momentum.
- As a result, we believe that the RBOCs will shift their spending from long-distance to step up their efforts to upgrade networks for broadband access.
- Carriers are expected to step up ADSL equipment purchases for Central Offices should benefit Alcatel and Orckit.
- Alcatel is the primary ADSL supplier to the RBOCs (JPC).
- Orckit also is well-positioned, with single-source GTE and potential 2nd source for RBOCs as decisions are made on SONET/DWDM/OPTICS.
- In addition, ADSL ramp should have a secondary benefit for suppliers of backhaul equipment -- Lucent and Alcatel.
- Upcoming conferences (Interop and SuperComm) could provide forum for ADSL-related announcements.
Large Cap Beneficiaries. We believe that the primary large cap plays are Alcatel and Cisco. Alcatel (ALA, BUY, $23), as the primary supplier of ADSL equipment to the RBOCs, probably stands to benefit from an increase in ADSL deployment more than any other equipment provider in the market. In addition, we expect that Cisco (CSCO, BUY, $112), due to its position in the marketplace and ability to deliver end-to-end data solutions for the CLECs, should be a primary beneficiary of these non-RBOC service providers' increased funding levels.
Small Cap Beneficiary. We believe that the primary small cap play in this market will be Orckit (see Orckit note dated 3/30/1999). Orckit Communications (ORCTF, BUY, $19) represents a near pure play on an increase in ADSL deployment in the U.S. Orckit is the ADSL equipment supplier for GTE, which is expected to significantly ramp up its ADSL deployment in 1999. In addition, we believe that Orckit is well-positioned to secure second-source status at one or more of the RBOCs in 1999. The expected ramp in ADSL later this year, combined with continued cost improvements, is expected to lead the company to profitability in 2H99, and the company's cost structure and low share count create significant leverage to Orckit earnings.
- RBOCs are beginning to feel pressure from competitive access providers, and are beginning to respond. For the past couple of years, there has been a fair amount of talk in the telecommunications industry regarding the potential threats to the RBOCs' historic stranglehold on the local loop: cable modems, CLECs, etc. Up until recently, this talk has failed to materialize into a significant threat to the RBOCs. Consequently, there has been relatively little incentive for the RBOCs to upgrade their local loops for broadband access in the form of ADSL, as cable modems had not (until recently) seen deployment momentum and CLECs network buildouts had not become a real threat. As a result, the RBOCs have responded slowly, causing ADSL companies to push out expectations for years. However, recent discussions with carriers and equipment providers have led us to believe that the RBOCs have finally begun to feel the competitive pressure from both CLECs and cable modem providers, and are now planning shift spending from long-distance to accelerate/expand deployment of ADSL in order to counter the threat.
- CLECs have seen significant increases in funding recently -- should benefit Cisco. Over the past several months, CLEC funding has seen a dramatic pickup, placing these companies in the position to dramatically build out their networks. Examples include the recent IPO of Covad (market cap of $3.3 billion); the expected upcoming IPO of Rhythms and the potential IPOs of other companies in this space (North Point & RedConnect, owned by Comdisco); and the recent explosive rise in other stocks in this area (e.g., Globix). It is clear, then, that data-oriented CLECs have seen significant increases in funding levels recently, which will likely be used to build out broadband data access networks. We expect that the most likely immediate beneficiary of this capital influx will be Cisco, as the CLECs look to build out end-to-end infrastructures (Cisco Powered Networks).
- Cable modems have been also been picking up momentum. In addition, cable service providers from TCI/AT&T to Comcast/MediaOne have clearly articulated their belief that broadband access represents the future of their companies. More immediately, cable modem service has seen significant success in terms of adoption, with numbers reaching into the hundreds of thousands.
- As a result, we believe that the RBOCs will shift their spending from long-distance to step up their efforts to upgrade networks for broadband access. Our checks indicate that the RBOCs have begun to respond to these pressures by shifting their spending focus away from long distance and into broadband data access, both by accelerating previous ADSL deployment schedules and by expanding deployment plans.
- Carriers are expected to step up ADSL equipment purchases for Central Offices -- should benefit Alcatel and Orckit. Along these lines, Alcatel recently noted that it expects over 3,000 C.O.s to be equipped for ADSL access in 1999, and further noted that t expects to provision around 700,000 ADSL lines in 1999. In addition, Bell Atlantic recently announced that, whereas it previously expected to equip 250 C.O.s for ADSL access, it has increased this number to 750. As we have noted previously, we believe that the two primary beneficiaries of ADSL deployments in the U.S. are likely to be Orckit and Alcatel.
- Alcatel is the primary ADSL supplier to the RBOCs. Alcatel is clearly in the strongest position with the RBOCs due to its JPC win, which gave them Bell South, Bell Atlantic, Ameritech and SBC. In addition, it should be noted that a recent study by Allied Business Intelligence indicated that Alcatel is expected to have a roughly 40% share of deployments in the U.S. Thus, it seems clear that, as ADSL begins to ramp in the U.S., Alcatel remains the best positioned company to capitalize on this business.
- Orckit also is well-positioned, with GTE and potential 2nd source for RBOCs. In addition, Orckit, as the supplier to GTE and potential second-source at the RBOCs, remains well-positioned to benefit from the expected ramp in ADSL (see Orckit note, also 3/30/1999). In
addition, it should be noted that PairGain (PAIR-$9 5/8) is also a potential beneficiary, as its Avidia DSLAM platform is currently in trials with a number of carriers, including Sprint.
- In addition, ADSL ramp should have a secondary benefit for suppliers of backhaul equipment -- Lucent and Alcatel. In addition to the expected pickup in ADSL access equipment sales, it is worth noting that any significant acceleration/expansion of ADSL access will likely lead to increased demand for transmission and backhaul equipment in order to connect these additional lines to the network. We believe that the primary beneficiaries in this space would include Lucent and Alcatel.
- Upcoming conferences could provide forum for ADSL-related announcements. Networld/Interop will take place from May 10-14 this year in Las Vegas. In addition, SuperComm takes place from June 7-10 in Atlanta. These are the two largest networking-related conferences of the year and often provide the backdrop for several important announcements in the datacom/telecom industry, both from equipment vendors and from service providers. We would not be surprised to see several significant announcements this year regarding ADSL-related activities.
Investment Opinions.
Large Cap Beneficiaries. We believe that the primary large cap plays are both Alcatel and Cisco. Alcatel (ALA, BUY, $23), as the primary supplier of ADSL equipment to the RBOCs, probably stands to benefit from an increase in ADSL deployment more than any other equipment provider in the market. In addition, we expect that Cisco (CSCO, BUY, $112), due to its position in the marketplace and ability to deliver end-to-end data solutions for the CLECs, should be a primary beneficiary of these non-RBOC service providers' increased funding levels.
Small Cap Beneficiaries. We believe that the primary small cap play in this market will be Orckit (see Orckit note dated 3/30/1999). Of the companies in our universe, Orckit Communications (ORCTF, BUY, $19) represents a near pure play on an increase in ADSL deployment in the U.S. Orckit is the ADSL equipment supplier for GTE, which is expected to significantly ramp up its ADSL deployment in 1999. In addition, we believe that all of the RBOCs are likely to name second-source ADSL suppliers in 1999, and that Orckit is well-positioned to secure second-source status at one or more of these carriers. The expected ramp in ADSL later this year, combined with continued cost improvements, is expected to lead the company to profitability in 2H99, and the company's cost structure and low share count create significant leverage to Orckit earnings. In addition, PairGain (PAIR, BUY, $9 1/2) is also a potential beneficiary, as its Avidia DSLAM platform is currently in trials with a number of carriers, including Sprint. |
