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Components Inventory Countdown

How is life at the bottom of the food chain?

In the past month, financial analysts have predicted an uptick in carrier spending toward the second half of 2002, indicating that things are returning to "normal" in the carrier world, whatever that may be (see Analyst: Upgrades All Around! and Sagawa Calls for Rebound (Again)).

But how long will it take for this effect to filter down to the vendors whose weird widgets wire up carrier networks?

Maybe longer than they'd like. A research report from Credit Suisse First Boston (CSFB), issued last week, analyzes the current components inventory levels of ten key public components companies and compares these with projected purchases of optical systems. Called "Optical Components Inventory Revisited," the report updates a similar report originally published in November 2001.

The good news, says CSFB, is that excess component inventory levels today are down 75 percent from the year-ago peak of $1.9 billion. The firm estimates the excess inventory at $490 million, which is basically in line with figures it forecast six months ago.

The bad news is that systems sales are turning out to be weaker than originally forecast, which means that the inventory overhang will likely last until 2003, several quarters longer than originally anticipated. Further, the report cautions that not all components are created equal, so some vendors will emerge from that overhang much sooner than others.

"We believe that the demand and recovery will have several distinct stages to it," writes Max Schuetz, principal author of the report. "In addition, we believe that the order of those stages will be the exact reverse of the order in which the network segments were constructed."

Table 1: Component Recovery Staging
Build Order Recovery Order Item Components Vendors

1

6

Physical Construction -- Obtain rights of way, dig ditches, install conduit, construct amplifier huts

2

5

Fiber -- Run fiber cable through conduit fiber, cable GLW (33%)

3

4

DWDM Systems -- To light a pair of fibers, carriers install DWDM muxes on each end of the pair and deploy amplifiers in the huts mux/demux components, pump lasers, EDFAs JDSU (30-35%), GLW (5%), most smaller vendors

4

3

DWDM Line Cards -- Each DWDM mux can support 32-160 wavelengths. Each wavelength is supported by a separate pair of line cards source lasers, modulators, photodiodes, drivers, PHY chips, framers, mappers, FEC JDSU (20-25%), AGR (10-15%)

5

2

Sonet -- Generally the data payload carried over the DWDM wavelengths is a Sonet or SDH stream Sonet muxes, transceivers, 1310nm lasers, framers, mappers JDSU (5-10%), AGR (5-10%), OCPI (90%)

6

1

Service Feeds -- While some capacity is sold wholesale in wavelengths, most is fed by a carriers own service aggregation infrastructure edge routers, ATM switches, DCS, class 5 switches
Source CSFB. Adapted from Exhibit 5.


First to recover will be edge components, typically low-speed OC3 (155 Mbit/s) and OC12 (622 Mbit/s) Sonet transceivers, which are used to populate interfaces in edge routers, ATM switches, and aggregation equipment, CSFB says. Carriers continue to add this type of equipment incrementally as they attract new customers to their networks.

Several vendors are set to benefit from the recovery of this segment. Optical Communication Products Inc. (OCPI) (Nasdaq: OCPI) is the most heavily focused on this space, and as a result, Schuetz predicts, it may do better than expected in the March quarter. Agere Systems (NYSE: AGR) and JDS Uniphase Inc. (Nasdaq: JDSU; Toronto: JDU) are also key players.

Schuetz also suggests that the projected early recovery of low-speed Sonet devices may explain why companies like Agere, Agilent Technologies Inc. (NYSE: A), and JDS Uniphase seem to have increased their interest in this space. JDSU, for example, bought the enterprise transceiver business from IBM Corp. (NYSE: IBM) in December 2001 (see JDSU's Bid for the Enterprise).

The DWDM line card market will be next to emerge, in CSFB's view, probably in the second half of this year. Agere and JDSU are the leaders in this space, as both have a complete product line of line card components.

Last to recover will be components that are built into chassis deployments, such as optical amplifiers, mux/demux components, and dispersion compensators, says the report. Vendors selling into this category include Corning Inc. (NYSE: GLW), JDS Uniphase (again), and many of the smaller components firms, which will have to wait until "well into" 2003 before they see a significant upturn in sales.

Schuetz has one final word of warning: "Severe pricing pressure could rapidly follow a demand improvement in this space." When the capacity glut has been worked out, competition is going to be more fierce for a couple of reasons, he believes.

For starters, OEMs (those that haven't already spun off their components activity) will soon deplete their own internal reserves of components and will turn to external vendors in order to get the best prices. At the same time, components vendors will be "flexible" on pricing, in an effort to capture new areas of revenue growth.

— Pauline Rigby, Senior Editor, Light Reading
http://www.lightreading.com
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