Optical/IP Networks

Optical Death Greatly Exaggerated

Of course optical networking is not dead. It's just not as rich.

If visionaries in the optical market are to be believed, this week's market correction in the optical sector was just a chink in the industry's financial armor -- a reality check for overzealous valuations.

George Gilder, the widely watched technology guru and publisher of the Gilder Report, says he doesn't pick stocks. But he does manage money. Perhaps he described the scenario best as he spoke at the Forbes/Gilder conference in New York on Wednesday night:

"It wasn't a good day. I spent most of the day on the treadmill, watching CNBC and reading this book called 'The Coming Internet Depression.' " His assessment: "The book was interesting, but it was wrong. The existing Internet cannot accomodate the thousands of business plans that are out there. The Internet must be rebuilt."

The stock market, however, has sent some clear signals about the pace of investment in the global network. Nortel Networks Corp.'s (NYSE/Toronto: NT) quarterly conference call spooked the market because it widened the credibility gap between growth forecasts and actual results in optical networking equipment companies. If you promise massive growth, you must deliver.

Stock prices in the optical systems and component companies have dropped roughly 20 percent to 40 percent this week. Some of the hardest hit stocks included Nortel, down 36 percent this week; Ciena Corp. (Nasdaq: CIEN), down 34 percent; SDL Inc. (Nasdaq: SDLI), down 37 percent; and JDS Uniphase Inc. (Nasdaq: JDSU), down 34 percent. Networking processor manufacturers also suffered: Applied Micro Circuits Corp. (Nasdaq: AMCC) was down 35 percent, and PMC-Sierra Inc. (Nasdaq: PMCS) was down 26 percent. Still, the venture market moves forward. Innovation moves forward. Product development moves forward. And carriers that stop investing in optical technology will certainly not survive, pundits say.

"It's not dollars in peoples' pockets, it's the ideas in peoples' heads that drive economic health," says Gilder.

Indeed, in the midst of this correction, the message might be that service providers need to use more brainpower and technology, rather than accomplishing their goals through blind spending.

"These big carriers have to spend much more wisely; they can't spend billions to scale the old fashioned way," says Scott Clavenna, president of PointEast Research and director of research for Light Reading. "This is still a huge opportunity for optical startups."

Tonight, more growth data is eagerly awaited: JDSU will report earnings after the market's close. The company's stock is down nearly 30 percent this week on fallout from Nortel's lower than expected sequential growth. Because Lucent and Nortel represent JDSU's two largest customers, recent troubles at Lucent and slower growth at Nortel have punished the stock.

Analysts will look to JDSU's quarter to gauge demand for the fourth quarter and beyond. Wall Street's eyes and ears will focus on what JDSU executives say tonight about future growth.

"There is more concern for the future," says Nikos Theodopolous, analyst at UBS Warburg. "They're concerned more about what will happen in the fourth quarter."

As for the stock market: Has it become one large red-tag sale for optical stocks? JDSU at $65? Nortel at $45? A small but vocal minority believe just that.

"We believe what we saw was last night was an overreaction since Nortel did not miss its official guidance, nor did it back off from that guidance one bit," wrote Charlie Gawlak, associate analyst at Wit Soundview (Nasdaq: WITC). "That means the growth should push back up over 100 percent this quarter."

"The issue right now is the valuations," says one managing director at a Wall Street firm, asking not to be named. "The multiples are coming down."

"Valuations were really ludicrously high, and we were due for some kind of correction at the first sign of bad news," says Clavenna. "But it seems like it might be a buying opportunity."

Tonight, investors will look for signs from JDSU that the coast is clear.

-- R. Scott Raynovich, executive editor, and Marguerite Reardon, senior editor, Light Reading http://www.lightreading.com

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