Optical/IP Networks

Alcatel Optronics: How High Can It Fly?

Alcatel Optronics (Paris: CGO.PA; Nasdaq: ALAO), the optical components division of Alcatel SA (NYSE: ALA: Paris: CGEP:PA) reported strong third-quarter earnings today. But analysts say the division's potential could be constrained by its powerful parent.

Alcatel Optronics, for which Alcatel has created a special tracking stock (see Component Spinoffs: Dynamite or Duds?) reported third-quarter sales of Euro 124.9 million (US$148.5 million), a 173 percent increase over last year's third quarter. Income from operations was Euro 26.6 million ($31.6 million), 255 percent higher than last year's figure.

Management credited the gains to a push for new sales, particularly in the area of component subsystems, which now comprise 50 percent of Optronics' business, compared to one-third of its business last year. Optronics does the other 50 percent of its business in discrete components like pump lasers.

Optronics execs said that sales for the year are on track to more than double, while income from operations will triple.

However, not everything's rosy. For one thing, Optronics execs said that next-quarter growth will be be single-digit only, due in part to component shortages that could affect the division's ability to meet its orders. And there's another shortfall this quarter: Net income was down Euro 4.8 million ($5.7 million), attributed by Optronics to goodwill amortization and the division's purchase of fiber Bragg grating maker Innovative Fibers Inc. this summer for $175 million (see Alcatel Buys Fiber Filters).

Alcatel Optronics says the Innovative Fiber buy will build its business. Other moves include plans to spend Euro 250 million ($297 million) on expanding its manufacturing facilities from 19,000 square meters to 85,000 square meters over the next year. And it's embarked on a program to streamline its operations by assigning specific component specialties to different plants worldwide.

Good news overall. But questions lurk about the division's ability to establish itself in the market and to build value independently of Alcatel.

For instance, some question whether Optronics is being aggressive enough in its pursuit of the optical components market. Executives said today in a conference call that they're undecided on how to invest in R&D. "MEMS are great for certain applications, but we are confident that eventually, the winning technology will be SOAs [semiconductor optical amplifiers]," said Optronics CEO Jean-Christophe Giroux. "Do you spend a lot of money and effort on ideas that may be dated a couple of years from now? It's a difficult call."

But analysts say it's a call that needs to be made. "They don't have a very aggressive stance in terms of technologies," says Alexandre Peterc, an equities analyst with European investment bank CDC Bourse. "The MEMS market's filling with players. It's going to be a tight space. If I were in their shoes, I'd be conducting full-out R&D instead of trying to decide what to do."

Giroux also said that Optronics is wavering in its decision whether to build or to continue buying 980-nanometer pump laser chips from SDL Inc. (Nasdaq: SDLI). Optronics management seems bent on preserving the SDL relationship, despite ongoing complaints about components shortages and the fact that SDL is in the process of being acquired by archrival JDS Uniphase Inc. (Nasdaq: JDSU). "You have to ask, 'What's going on here?' " Peterc complains.

Some analysts question whether Optronics is capable of making its own decisions at all, since it's reliant on Alcatel for incoming cash. This year's plant expansion, and the purchase of Innovative Fibers, for instance, came from funds provided by Alcatel, not from Optronics' own coffers. But Optronics execs say that's not an issue.

"Alcatel will continue to fund us," said Giroux. "That's good, because it forces us to be clear about what we want. Alcatel so far has met our requirements. What would be the point of spotlighting Optronics in order to shut the bathtub off the following morning?"

Analysts' focus today ultimately strayed to the value of Optronics as a separate tracking stock. "You can really only crystallize your investment in Optronics when and if ALA wants to sell the shares," said one analyst. "It's still not a good reflection of the real value of the company."

Although Alcatel priced the original Class O shares for Optronics at about US$71, they've been trading lower than that ($62 today, up a full point at midday). Optronics execs say that's strictly due to current market negativism. Shares in Alcatel, which also reported its earnings this morning (see Alcatel Posts Record Q3) and followed up with news of a big deal with 360networks Inc. (Nasdaq: TSIX; Toronto: TSX.TO) (see Alcatel, 360networks to Partner), rose nearly 5.25 points today and were trading at $62.38.

-- Mary Jander, senior editor, Light Reading http://www.lightreading.com

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