Analyst Report Defends Optical
The debate over declining carrier capital spending rages on in the analyst community. On Tuesday, Morgan Stanley Dean Witter released research that reassures investors that optical vendors won’t be affected.
The report may come in handy on Wednesday. Following Nortel Networks Corp.'s (NYSE/Toronto: NT) earnings call on Tuesday, the optical market was rattled by news that Nortel's sequential quarterly growth in optical systems slowed, despite strong numbers all around. Most optical networking stocks were down dramatically in after-hours trading on worries that inventory had been poorly managed by Nortel, which could have implications for components vendors such as JDS Uniphase Inc. (Nasdaq: JDSU).
Morgan Stanley's report comes nearly a month after analysts from Sanford C. Bernstein & Co. Inc. downgraded stocks in anticipation of reduced capex spending by service providers (see Report Downgrades Cisco and Nortel ).
Specifically, Morgan Stanley picks core optical vendors, like Alcatel SA (NYSE: ALA: Paris: CGEP:PA), Ciena Corp. (Nasdaq: CIEN), Corvis Corp. (Nasdaq: CORV), Lucent Technologies Inc. (NYSE: LU), Marconi Communications PLC (London: MNI), Nortel, and Sycamore Networks Inc. (Nasdaq: SCMR). But it cautions investors to examine players in the metro access market more carefully.
Why so positive on optical? There are several reasons. Despite the hype surrounding failing competitive local exchange carriers (CLECs), these carriers only account for a small portion of spending on optical equipment, says the report. Interexchange carriers (IXC) like AT&T Corp. (NYSE: T) and WorldCom Inc. (Nasdaq: WCOM) account for most of the spending. In 1999, IXCs accounted for 89 percent of spending on dense wavelength-division multiplexing (DWDM), according to research recently published by Ryan Hankin Kent Inc. (RHK).
Still, a few vendors have already fallen victim to CLEC problems. For example, Ciena reported it would take a charge in its fourth fiscal quarter to cover up to $28.2 million in uncollected receivables when an order was cancelled by London-based provider, Iaxis. Sycamore also told Morgan Stanley that it would no longer be expecting revenue from Sphera Optical Networks Inc.. This could potentially affect metro transport vendor ONI Systems Inc. (Nasdaq: ONIS), which just announced a contract win with Sphera. Cyras Systems Inc. could also be affected by the financial troubles of one its customers, ICG Communications Inc. (Nasdaq/Neuer Markt: ICGX), a CLEC that has lost over 90 percent of its value in the last few months (see ICG's Sinking Ship).
Because of cheaper deployment costs and service capabilities, optical equipment generally pays for itself in a relatively short amount of time. For example, Morgan Stanley estimates that ultralong-haul gear costs anywhere from $30 to $45 million compared to the $200 to $220 million it costs for Sonet transport gear. Some metro equipment can pay for itself in as little as three months, according to the report.
As stock prices of certain carriers continue to fall, it stands to reason that some spending will have to be cut. That makes sense, but Morgan Stanley predicts that carriers will reallocate money and spend more on optical equipment.
“We believe that carriers have invested significantly in new fiber over the last few years, and that currently only about 16% of new fiber in North America has been lit,” says the report. “As networks evolve to packet-based architectures, we expect spending on traditional voice equipment to decline.”
While the outlook is positive for the long-haul market, the success of metropolitan area equipment vendors looks a bit fuzzier, according to Morgan Stanley. For one, these smaller metropolitan area providers tend to be weaker financially. In addition, deployments of metro equipment are more sensitive to expenditure on access equipment.
But on the positive side, DSL and cable modem deployments are up, which should fuel demand in the metro transport market. Also, the market for metro is so small at the moment that rapid growth shouldn’t require a significant surge in spending.
-- Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com