Components Competition Is Killing
ANAHEIM, Calif. – OFC/NFOEC 2005 – A few years ago, many believed the optical components industry would be stabilized by 2005. So, what happened?
Some top industry executives discussed their theories -- and possible routes to recovery -- in the "State of the Industry" panel at yesterday's Optical Society of America's Executive Forum, a precursor to the Optical Fiber Communication Conference (OFC) here in Anaheim.
No one is under the illusion that the optical components industry is healthy, especially given negative gross margins at Avanex Corp. (Nasdaq: AVNX) and Bookham Inc. (Nasdaq: BKHM; London: BHM). (See Avanex Slips on Tepid Outlook and Bookham Still Bleeding .) The problem is the same as it's been since the dotcom bubble burst: The number of competitors is too high for the amount of business available, and that means prices are falling unreasonably fast.
"We're competing ourselves to death," said Bookham CEO Georgio Anania, noting that prices in some cases are "30 to 40 percent" lower than they should be. "We haven't gotten the prices back to where it makes sense."
That's a well known problem, but components players still haven't found a way around it. "If we continue down the path we're on, it's not clear how we get to what I call a healthy sector," said Jo Major, CEO of Avanex.
Optical components were a premium industry during the bubble, crafting specialized technology for the inherently expensive network core. Today's equipment vendors are targeting metro and access plays, and they want parts to be cheap and interchangeable. The components industry still hasn't made the full adjustment to that model, some panelists argued.
"We are a very technology-driven industry, and a lot of the time, [customers] don't care," Major said. "Not understanding the economic models and economic barriers [is] a big obstacle to us being profitable."
To demand higher margins would be risky, but Anania proudly noted his company recently has had the "courage" to do so. "At some point, you say, 'I'm sorry, but it's worth more,' " he said, acknowledging that Bookham had lost some business in the process.
Another adjustment comes with system vendors' increased use of contract manufacturers, which carry little or no inventory and insist that parts be shipped immediately. The result is a much shortened lead time for components vendors. "That's something we're going to have to live with for a long time," said Harry Bosco, CEO of Opnext Inc.
But consolidation -- the expected disappearance of companies through mergers or closures -- won't fix the problem by itself. "I'm not sure a simple consolidation strategy takes us to a place that's all that interesting," Major said.
Frank Levinson, chief technology officer of Finisar Corp. (Nasdaq: FNSR), agreed, noting that components players haven't found success by acquiring each other just to buy market share. "That's a zero-sum game," he said.
The real key is to find higher-volume markets for optical components, the executives agreed. That would drum up more business, of course, and it would help some vendors recoup the expenses they're pouring into fabrication facilities.
War on Copper
To drive up volumes, Levinson cried for a war on copper. In Gigabit Ethernet, he noted, fiber is able to show better performance and lower power consumption than copper. But devices for copper transport come at a lower price -- partly because optics firms demand too much of a premium for those superior specifications -- and copper is already in the walls of every business. So far, copper has won.
"We lost and we keep losing," Levinson said. "We have to make sure that 10-Gbit/s Ethernet doesn't go to copper."
Bookham believes the key to better margins is to continue owning its own fabs, because its research into manufacturing processes pays off with components that can justify better prices. "Where we make differentiated chips, we make very nice margins," Anania said.
Most components players are also trying to shore up revenues by diversifying beyond telecom. Opnext, for example, is filling its fab by producing lasers for recordable DVD drives, Bosco said. This provides some revenues while waiting for the telecom market to stabilize.
Most executives agreed that companies have to pick one of two strategies: Become a large company with a breadth of products, or stay small and pick a lucrative niche. "Getting stuck in the middle is the most difficult" case, said Gary Wiseman, general manager of Intel Corp.'s (Nasdaq: INTC) optical platform division.
Still, optical components manufactureres must confront the lack an easy market akin to that of the PC, said analyst Tom Hausken of Strategies Unlimited, who was in the audience for the panel session.
Most microprocessors are cheap, low-margin parts, but those that go into PCs are marquee, high-volume items that bring home the big money. Optics lacks that superstar device, because there's no system defined by its optics the way a PC is defined by its CPU, Hausken noted: "We're not like that. [Systems vendors] have electronics and software to worry about. They don't care as much about us."
Defending Your Life
For the public companies, whose numbers are out in plain view, scrutiny is particularly high. One audience member bluntly challenged the Avanex and Bookham CEOs to explain "why you're going to be in business 12 months from now."
For Bookham's answer, Anania reiterated the company's strategy of fab ownership, admitting it's "high risk" but saying it should pay off by giving Bookham some premium products. Bookham's cash burn should decrease as the company moves its manufacturing to Asia, he noted; expenses remain high while the transition is in process.
Avanex, meanwhile, is undergoing a shift to Asian outsourcing and may be planning to raise more capital. "I believe that we have the ability to raise the cash to fully turn it around," Major said, adding that the company will look "completely different" once its restructuring is completed. Being a public company, Avanex can't give out details of its capital plans, he added.
Executives pointed out that the industry isn't all cobwebs and gloom. As Anania has noted before, Bookham is seeing demand grow, to the point where the company is running some production lines at full capacity.
And, Major noted, the submarine networking business, largely dormant for the past three years, is resurfacing (so to speak). (See Alcatel Lands Monster Nigeria Deal and FLAG Picks Alcatel for Subsea Cable.) Avanex acquired Alcatel's components business in 2003 and will likely be a supplier to Alcatel for submarine parts.
— Craig Matsumoto, Senior Editor, Light Reading