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Optical/IP

Notes From Needham

NEW YORK – Could it be, would it be, that investors are actually interested in optical and telecom companies again?

Sure seems that way. At the Needham & Co. Growth Conference held here this week, more than 2,000 investors prowled 350 presenting companies. Yes, many of them weren’t in telecom but in red-hot fields such as biotech, but communications technology firms drew plenty of interest – and in some cases, standing-room only crowds.

The Needham conference is unique in its focus on companies generally under $1.5 billion in market capitalization. And real deals are cut in the hallway, where private equity and hedge-fund investors might want a piece of a potential upcoming IPO or a small, undiscovered public company. With Nasdaq purring along (at least during the earlier part of the week), there was buzz in the hallways. That’s right! Real-live investors actually talking about putting money into telecom technology. Can you believe it?

At any rate, here’s a rundown on some stuff that was said.

Needham on IPOs
The word from George Needham, the founder of his eponymous investment bank (there – I’ve always wanted to use the word “eponymous”), is that the IPO market will be progressing nicely in 2006.

”We see a revived IPO market,” said Needham in a luncheon address on Tuesday. “For a while, the VCs got out of control and thought they could build a company in two to three years. It takes seven to eight years. We see a lot of quality IPOs coming out in 2006."

Who might that be from the telecom market? Of the telecom companies presenting, Needham mentioned Airvana Inc. in particular.

Seeking Airvana
Speaking of Airvana, CEO Randy Battat, a guy with youthful exuberance who looks as if he could sell snow shovels in Ethiopia, let this tidbit fly: Airvana, which is primarliy selling EVDO techology with the help of partners Nortel Networks Ltd. and Ericsson AB (Nasdaq: ERIC), is interested in a potential Verizon Communications Inc. (NYSE: VZ) project to supply broadband to the airlines.

Some background: Verizon announced on December 12 that its Airfone division is looking to purchase 800MHz spectrum in a government auction so that it can supply broadband to airplanes using ground stations. Battat said the spectrum auction is now scheduled for May, and Verizon is serious about the project.

”We could be building that business,” he said.

In the meantime, he sees bright prospects for 1xEVDO technology, in which Airvana specializes. Battat notes that at Verizon, data is now up to 8 percent of all wireless revenue, whereas a year before it was 4.7 percent.

”We’re in the earlier stages of a nascent business. When Sprint and Nextel merged, if you look at their presentations and the documents they’ve filed with the SEC, you’ll see lots of it is about EVDO."

Sounds bullish. Well, what did you expect from a youthfully exuberant guy at a growth investment conference?

The other Kennedy
JDSU (Nasdaq: JDSU; Toronto: JDU) CEO Kevin Kennedy, the quiet behind-the-scenes-turnaround-expert, sees progress in JDSU’s return to profitability. He reaffirmed, that, according to plan, JDSU expects to return to be "non-GAAP EBIDTA" profitable in its second fiscal quarter of 2006. He also noted that he thought business in the communications market was “favorable,” “slowly recovering,” and showing “vigor.”

Yes, these are the kinds of words that get spoiled, preening hedge-fund types excited. In fact, we overheard one interested hedge fund manager chatting with a JDSU investor relations professional, saying, “Yes, we’ve noticed the stock acting better and it’s got our attention.”

Kennedy gave the investment crowd something to bite into: He said that JDSU’s cost-cutting and recovery efforts were far from done, and described the company as being about halfway through an 18-month project. Referring to the company's manufacturing changes and cost cutting, Kennedy says: “It will take many more quarters to fully reap the benefits...”

JDSU has been transferring nearly all of its manufacturing facilities to lower-cost Asian locations. Once that’s complete, said Kennedy, it takes more time to get production yields to where they need to be, shut down the remaining North American plants, and fully reap the benefits of the M&A integrations. (See 2005 Top Ten: M&A, Leading Lights Finalists, JDSU Buys Into Testy Market, Investors Smile on Optics, JDSU Sells More, Cuts More, and LR Names Best Investment Finalists.)

When asked by one member of the audience why consolidation among optical components companies wasn’t happening more quickly – and why JDSU didn’t buy more competitors – Kennedy didn’t mince words: “ I don’t want to help my competitors get restructured, even if they belong to me. It’s more likely that they will go bankrupt and get restructured, or else they will get privatized and the assets will be redistributed."

So, how do you really feel, Mr. Kennedy?

Embed with Huawei
Who knew? Shares in optical components supplier Oplink Communications Inc. (Nasdaq: OPLK) are up 60 percent in just the last six months.

Much of that might be associated with growth at Huawei Technologies Co. Ltd. with which Oplink is closely tied. In fact, Oplink might be the best way for investors interested in Huawei to play the Chinese equipment supplier, at least while it remains private. Oplink CFO Bruce Horn, presenting on Thursday, said Huawei business reprents 20 percent of Oplink’s revenue.

”We expect Huawei to be a major customer of Oplink’s,” said Horn. “We recently put an office in Shenzen. We’ve been told by Huawei that we’re their number one passive supplier. We’re well embedded with Huawei."

Embedded with Huawei – now that sounds sexy.

Another interesting tidbit: Horn says that CWDM growth is taking off, and he expects Oplink’s coarse wavelength-division multiplexing (CWDM) business to double in the next year. The main driver? Cisco Systems Inc. (Nasdaq: CSCO) is using more CWDM components in enterprise boxes. Horn also cites growth in CWDM products at ADVA Optical Networking , which is also an Oplink customer.

Is it Good enough?
Wireless provider Good Technology Inc. CEO Danny Shader made a good case on how his company stands apart.

Here’s the Good pitch, in a nutshell. The company offers a Blackberry-like service that allows corporate users access to their work applications, including email, over a wireless network that also supplies service and support (and hopefully without the patent headaches). The twist is that Good has focused its software and service on open PDA platforms such as PalmOS and Microsoft Mobile, and it’s partnering with existing wireless providers like Sprint Corp. (NYSE: S) and Cingular Wireless . BlackBerry 's Blackberry service is a proprietary operating environment.

”I don’t believe there’s anybody that wants to build applications in a proprietary environment,” said the Real Slim Shader.

The Good CEO also said his company is moving to a reseller model, whereby it partners closely with operators to distribute its service, Goodlink.

Shader says that by partnering with the operators, the company can provide service assurance and support that is integrated with the network. He believes corporations are willing to outsource their wireless applications if they have SLA and service support. After all, said Shader, IT guys really don’t want to figure out how to provide employees with PDA access to applications over a third-party network.

”You need to have end-to-end control in a network operations center model. You need SLA [service level agreements]. The NOC-based model will win in medium-to-large enterprises. If you can deliver standards, security, and support, it keeps the cost of ownership down."

Sounds good to us. Glass house
There aren’t many more dramatic technology stock turnaround stories than Corning Inc. (NYSE: GLW). The stock’s up about 2,000 percent since its bottom in 2002. (See Investors Smile on Optics and JDSU, Corning Get Upgrades.)

James Flaws, Corning's vice chairman and CFO, was the lunch speaker on Tuesday. He pointed out that much of Corning’s recent success has come on the backs of the LCD flat-panel market, which, interestingly, now represents the bulk of Corning’s business. (Remember when they were big into this thing called fiber optics? Or casserole dishes?)

Just in case you live in a cave, older CRT video display technology is being replaced by flat-panel LCD screens. Corning makes the glass for those panels, and Flaws says he expects its LCD technology share to increase to 80 percent of the monitor market by 2007.

So what about optical fiber? Flaws (well, nobody's perfect) says that thanks to the FTTP buildout by Verizon, that market is growing again. But he wasn't overly effusive. “It’s tough to get excited about it when you only have one vibrant customer,” he said, referring to Verizon. “Until we see other telecom [companies] doing what Verizon’s doing, we can’t see this sector having much vibrancy.”

Sour on Sonus?
Seems like every time Sonus shows up in an investment context, you can expect the usually raving crowd of lunatics following the company, whether they be wild-eyed enthusiasts or bitterly burned skeptics. (See Sonus Misses in Q3, Sonus Chief: Come Fly With Me! , Sonus Shares Latest Thrill , and Sonus Finance VP Quits.)

Sonus president Bert Notini did his best to present in front of a packed-house of seemingly tense Sonus stockholders, positioning the company as a leader in the fixed/mobile convergence sector, with that market's need for softswitches and upcoming IMS-based applications. (See Readers Pick IMS Killer Apps and BellSouth: The IMS SuperBowl? .)

Fine, say investors, but what about the numbers? One moderately perturbed institutional investor asked the question that might have been on several other people's minds, namely: "You seem to always be announcing new orders, but when is that going to translate into profits?"

On cue, a finely tailored Notini went into full-bull mode, telling a packed room that big numbers could be just around the corner. "We are building out very large complex networks, and we have to wait until the networks are built [to recognize the revenue]. For us, that's a pent-up opportunity."

Hmmm, a pent-up opportunity. – as opposed to, say, an unpent-up opportunity. That's a good one. It's better than synergy, leverage, or even core competency. In the future (or "going forward"), we're going to keep our eyes open for more undiscovered pent-up opportunities.

— R. Scott Raynovich, Editor in Chief, Light Reading

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