Investors stampeding to buy shares in the hot optical component startup ignored warnings in its IPO prospectus.

February 7, 2000

4 Min Read
Avanex: Is it Worth $10 Billion?

When shares in Avanex Corp, http://www.avanex.com, an optical component startup, were traded on Nasdaq for the first time last Friday (Feb 4), they shot up to $172 by close of business - more than four times the $36 price of its IPO the day before.

On paper, that means that Avanex's market cap is now more than $10 billion, a staggering amount considering that:

- The only customer buying serious quantities of Avanex's products, MCI Worldcom Inc. http://www.wcom.com/, is also an Avanex shareholder. In fact, MCI Worldcom stands to make far more from investing in Avanex than it's spending on the company's products, so its value as a reference customer is questionable to say the least.

- Avanex only started shipping last summer and its revenues for the six months ending Dec 31, 1999 were a mere $10.9 million. In the same period, its losses totaled $19.8 million.

So why the stampede to buy Avanex shares? The answer could be that investors have learned to ignore the details in IPO prospectuses and ride the roller-coaster of Wall Street's infatuation with all things optical.

And they may be right. The future for Avanex could be very bright indeed if the vendor manages to deliver on all its promises. Avanex's developments could be key to carriers boosting the capacity of their fiber backbones by orders of magnitude at the same time as slashing costs and provisioning times. And that could solve an impending crisis for many service providers - coping with the explosion of Internet traffic on their networks.

But can Avanex deliver? The best way of addressing that question is to get a conceptual understanding of its developments. Right now, the product line up is as follows:

PowerFilter. A device that can be tuned to pick up light signals on multiple wavelengths, for use in DWDM (dense wave division multiplexing) equipment. It corrects insertion loss - fading of signals during filtering - enabling transmission over longer distances than was previously possible. This product represented 99 percent of Avanex's sales in the third and fourth quarters of 1999, according to its IPO prospectus.

PowerMux. This incorporates the PowerFilter and aims to raise the bar on DWDM performance, by enabling more wavelengths to be carried over a single strand of fiber at the same time as boosting the carrying capacity of each wavelength. It also incorporates optical add-drop multiplexing functions, enabling wavelengths to be redirected onto other fibers without having to be converted into electrical format. The PowerMux is shipping, but not in volume, according to Avanex's prospectus.

PowerShaper. This component re-shapes optical signals suffering from "chromatic dispersion" - smearing caused by different frequency light within individual wavelengths traveling at slightly different speeds. This promises to eliminate the need for electrical regenerators on long distance routes in carrier backbones, which sometimes account for half their costs, and make upgrades to higher speeds a laborious process (see Optical Illusions). The PowerShaper is in beta trials at present.

The developments may sound pretty cool, but the jury's out on whether they will live up to expectations. As noted, the only customer buying serious quantities of PowerFilter products is MCI Worldcom, and any evidence it could give is tainted by its vested interest in Avanex.

Here's the details, which are spelled out in Avanex's IPO prospectus on http://www.freeedgar.com, a listing of filings to the Securities Exchange Commission:

Sales to MCI Worldcom accounted for 92 percent of Avanex's net revenue in the third quarter of 1999 and 85 percent of its net revenues in the fourth quarter of 1999.

MCI Worldcom Venture Fund, a wholly owned subsidiary of the carrier, together with Microsoft Corp. http://www.microsoft.com were early investors in Avanex.

While Avanex sold 6 million shares at $36 each to the general public in its IPO last Thursday, it also sold MCI Worldcom and Microsoft a further 384,615 shares each for a bargain price of $13 a share. In other words MCI Worldcom spent just under $5 million to acquire shares that were worth $66 million by close of trading on Friday - paper profit that's way in excess of what it's spent on Avanex's products.

--by Peter Heywood, international editor of Light Reading http://www.lightreading.com

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