Optical Elevators?

Scott Clavenna photo I’ve noticed something strange about second-round financing: It convinces optical networking vendors they can defy gravity. Pockets stuffed with VC millions, they crowd into a cramped elevator while the cables creak and make dreadful popping noises overhead.

Established carriers aren’t deaf to these ominous sounds, especially since they’re being asked to commit to companies that may take a nosedive in the next eighteen months.

But startup carriers are thrilled to see that elevator fill up. More vendors mean lower prices and sharply differentiated business models. There’s also the possibility of equity-based relationships, which actually make choosing a particular vendor profitable.

So we have lots of startup vendors getting contracts from startup carriers. Not coincidentally, these deals are sometimes arranged by investors common to each party who also give their blessing to the contract that inevitably follows — say, a $15 million to $20 million commitment over two years.

These deals don’t always pan out, of course, but investors are wise to make the requisite introductions, and for the most part this practice is harmless and fair. We’re also likely to see a lot more of it over the next five years, as venture capitalists increasingly fund “optical Internet” service provider startups.

So why all my glum talk about overcrowded elevators and creaky cables? Because these brokered deals help create the impression that the optical networking market is going to keep climbing forever, in defiance of the laws of gravity.

Slumps are inevitable. Vendors’ first contracts usually come with plenty of strings attached (and may not be real contracts at all). Still, they give the appearance of unqualified success across all competing solutions. Every vendor gets funded. Each gets a contract from an emerging carrier within eighteen months of being launched.

But can every company be right?

The true test is the second contract. Ciena (Nasdaq: CIEN) was there at the birth of the optical networking market, putting it in the enviable position of being almost the only supplier of equipment that every carrier needed. Pirelli and NEC were producing DWDM gear but didn’t have a committed strategy for delivering real solutions. Lucent (NYSE: LU) was focused on developing leading-edge optical technology, while Nortel (NYSE/Toronto: NT) was busy rebuilding its flagging telecom switch line.

Ciena’s first major contract was with Sprint (NYSE: FON). It followed up with another heavyweight deal with WorldCom (Nasdaq: WCOM). This was no ordinary contract: Ciena agreed to build out its manufacturing capabilities if WorldCom would commit to purchasing DWDM transport systems. WorldCom signed on the line; Ciena built a world-class manufacturing infrastructure and quickly became the premier supplier of long-haul open DWDM systems — a title it still holds. WorldCom bought more DWDM than Ciena ever asked them to, and everyone was happy (until AT&T came along — another story).

Times have changed dramatically since 1995. No vendor has a clear shot comparable to Ciena’s or a solution that every carrier can agree on or endorse. Still, getting that second contract remains the key to success. It will be instructive to see how companies fare in their sophomore year. Granted, they’re all coming out of the gate at different times, but they face nearly equal challenges.

Who’s gotten through so far? Sycamore Networks Inc. (Nasdaq: SCMR). Of course. Cerent, in spades. And Tellium, just this week. Corvis (Nasdaq: CORV) has, sort of. ONI Systems Inc. (Nasdaq: ONIS) definitely has.

That’s a short list. Some of the freshman companies with a single contract or a couple of similar contracts not yet fulfilled include Alidian, Appian, Astral Point, Chromatis, Quantum Bridge, and Redback (Nasdaq: RBAK). These are worth watching, particularly Chromatis, now that it’s been taken into the Lucent fold.

The list of companies with no contract at all is quite long, though many have yet to reach general availability. Sirocco has the possible benefit of living within Sycamore’s well-timed strategies. Cyras must now contend with the confusion surrounding its recently departed CEO. Zaffire also has an empty spot at the top, along with a story strong enough to sell itself today. Équipe has all the right connections, and the group at Tenor will likely succeed by the contagious force of their commitment to a vision.

It’s hard to find real losers right now, though a few are inevitable. Having met nine new startups in the past nine days with nine excellent ideas and impressive teams makes me believe that elevator may have room for a few more — even if the cable is made out of glass.

Scott Clavenna, Director of Research, Light Reading http://www.lightreading.com

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