Wall Street Watches Optics

Tuesday's relief rally in the technology sector had some important signals for the optical sector. Money flowed into stocks of networking and components vendors, proving investors still believe it's one of the most attractive tech areas.

Next-generation networking stocks such as Redback Networks Inc. http://www.redback.com (Nasdaq: RBAK), Juniper Networks Inc. http://www.juniper.net (Nasdaq: JNPR), Sycamore Networks Inc. http://www.sycamorenet.com (Nasdaq: SCMR), and Ciena Corp. http://www.ciena.com (Nasdaq: CIEN) roared back to life. Likewise, optical components specialists such as E-Tek Dynamics Inc. http://www.e-tek.com (Nasdaq: ETEK) and JDS Uniphase Corp. http://www.uniphase.com (Nasdaq: JDSU) showed similar strength.

"The telecom and cable equipment players are going to be the first to rebound," says Alan Bezoza, analyst with CIBC World Markets http://www.cibcwm.com. "The telecom operators are still spending significantly to upgrade their networks, so these are real companies, not dot-commers."

Some of Mr. Bezoza's picks are the optical components players, including Harmonic Inc. http://www.harmonicinc.com (Nasdaq: HLIT), C-Cor.net Corp. http://www.c-cor.com (Nasdaq:CCBL), JDSU, and SDL Inc. http://www.sdl.com (Nasdaq: SDLI).

On the equipment side, the communications suppliers have entered a bidding war to acquire the hottest new optical networking companies. This week, Lucent's (www.lucent.com; NYSE:LU) $4.5 billion purchase of Chromatis Networks Inc. (www.chromatis.com) was just another in a series of multibillion dollar acquisitions--some of which result in little or no revenues for the acquiring company.

The successful next-generation networking players will be the ones that can smoothly integrate acquired companies into their product portfolio and build the software to connect the boxes.

"It's intelligence and how they integrate the software," says Gina Sockolow, analyst with Brean Murray http://www.breanmurray.com. She says the current buying spree means nothing if the acquirers fail to integrate the products into their software strategy.

For the larger networking players such as Lucent http://www.lucent.com (NYSE:LU) and Cisco http://www.cisco.com (Nasdaq: CSCO), acquisition strategy is proving to be even more crucial. One only needs to look at the result of Lucent's $900 million payout last year for Nexabit Networks, which marketed a complex routing product that by all measures is still sitting on the lab floor, and compare it with Cisco's purchase of Cerent, which Cisco acquired last year for $7 billion, to see how M&A differentiates companies. Cisco's Cerent acquisition is already set to generate up to $1 billion in additional revenue on the books this year, and it is now the anchor in Cisco's optical networking strategy.

"Cisco has whole team that goes in and examines the technology and makes sure it's right, a somebody like Lucent doesn't have that," says Sockolow.

Emerging next-generation networking players such as Redback and Juniper now have an opening in the optical space--specifically the area known as metropolitan area networks (MANs)--and they need to make their move. The first vendor to integrate the emerging "edge" optical equipment across a common software switching and routing platform will be in a powerful position.

Redback has shown early success in integrating Siara, the company it got last year for $4.3 billion. This week, the Redback announced a metropolitan-area networking product, the SmartEdge 800, that is based on Application Specific Intergrated Circuits (ASICs) built by the Siara engineering crew. The product appears to have legs.

The early Siara success has made Redback one of the new favorites on Wall Street. For example, Socklow continues to rate it as a buy, saying "It has as much upside as Juniper at half the valuation."

Steve Levy, an analyst at Lehman Brothers, was also impressed with Redback's Siara story. "The announcement of the first release of the Siara product cements our view on the positive nature of the Siara merger," wrote Levy in a research note. "We believe this should also allay any concerns over the successful delivery of the fully-featured Siara product or its important ASIC component."

Levy has upped his Redback revenue forecasts as a result of the development of the new product line. He sees it contributing $15 million in revenue to the second half of 2000, as well as $120 million to the 2001 forecast. Mr. Levy expects $190.9 million of total revenue in 2000 and $440.2 million in 2001, with earnings per share of $0.46 predicted for 2001. He has reiterated a buy rating with a $160 price targe for year-end.

That's the power of a successful acquisition and what it can do to your share price: Redback shares are up 13 percent since last Friday. The growing importance of M&A now puts pressure on companies such as Juniper and Sycamore, both of which have valuations in excess of $20 billion but still need to make significant acquisitions to keep pace with the kind of growth that investors are demanding.

--R. Scott Raynovich, Executive Editor, Light Reading (http://www.lightreading.com

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