Smiles Abound at OFC/NFOEC

ANAHEIM, Calif. — There's no question OFC/NFOEC is off to its happiest start in years. Years of wrist-slashing panels about low revenues, vanishing buyers, and crippling oversupply have finally given way to talk of future profits and even IPOs.

But the industry hasn't chased away all the dark clouds, as serious questions remain about how the industry can consolidate and stabilize. Panelists at the The Optical Society (OSA) (OSA) Executive Forum 2006 explored the good and bad of the state of the industry yesterday.

Let's start with the good news. Persistent talk of fiber-to-the-home and new broadband services is stirring up demand in the optical sector at long last. Carriers are buying into the idea of flexibility in optics, meaning tunable lasers and reconfigurable optical add/drop multiplexers (ROADMs) are in vogue, panelists agreed.

And investors are starting to believe again. They've poured back into optical stocks during the past week on signs such as a surprisingly good earnings call from Finisar Corp. (Nasdaq: FNSR). (See Optical Stocks Climb Again, Finisar Ignites Optics Explosion, and What the Heck's With Avanex?) Private companies are claiming massive earnings growth, and at least two are hoping to go public by early next year, said Richard Craig, CEO of tunable-laser vendor (and privately held company) Santur Corp.

But it's not party time yet. Margins remain too low for most companies -- which is important because much of the innovation in optical networks must occur at the component level, and weak margins mean those component players can't invest in R&D.

That's one reason why private companies including Fiberxon Inc. , NeoPhotonics Corp. (NYSE: NPTN), and Optium Corp. (Nasdaq: OPTM) are the first to emerge with strong tales of revenue growth and even profitability. "There were some advantages in the last three to four years to being private, Craig said. "We could keep our investment in technology relatively high." He added, half joking, that there wasn't anything else to do anyway: "There wasn't anything being sold."

Most panelists agreed that oversupply is hobbling the industry's efforts to stabilize. Bookham Inc. (Nasdaq: BKHM; London: BHM) CEO Georgio Anania screamed for consolidation at last year's OSA gathering, and his tune was no different this year. (See Components Competition Is Killing.)

"Our industry needs to consolidate," Anania said. "What I don't want to see in three years is the same seven of us here trying to battle with 10 percent less operating margins."

The conference's moderators and organizers convened for the day's final panel, and mostly agreed that the industry needs consolidation of 25 to 30 percent. Bill Diamond, CEO of Xradia Inc. , outbid the others by saying 40 percent is required -- but greed and ego will probably keep the consolidation tally closer to 25 percent, he said.

One factor to watch is the recent runup in optical components stocks. That's giving some companies the extra valuation to stay alive -- but it might also help fuel consolidation by giving bigger companies the capital to acquire smaller ones.

More likely, some panelists said, the small private companies will continue buying each other, trying to gain the critical mass to be noticed against the likes of JDSU (Nasdaq: JDSU; Toronto: JDU).

Acquisitions will have limits, though. Most panelists didn't think a massive "one-stop shop" would make for a successful optics company.

"I think every one of our customers wants us to [acquire] everything," said Harry Bosco, CEO of Opnext Inc. (Nasdaq: OPXT) "No one company can invest enough R&D in it, and no one can get enough business to feed it."

That last point underscores the problem that communications optics have had all along: No high-volume product has emerged. Telecom, in particular, remains a market splintered into speeds and reaches. "There's so much mix in the product lines that it makes it difficult to efficiently use the fab," said Jane Li, a senior vice president with Eudyna Devices Inc. , formerly Fujitsu Compound Semiconductor.

Many companies are compensating by pushing their optics into other areas -- lasers for CD and DVD players being one example Opnext pursued. Likewise, the compound-semiconductor arms of California Eastern Laboratories (CEL) and Mitsubishi Electric & Electronics USA Inc. don't rely just on optics; they've got wireless business to help bring in revenues.

"You're seeing a lot of interest in trying to increase [their] markets," said Michael Lebby, president of the Optoelectronics Industry Development Association (OIDA) . Many of the association's members have asked for more information on markets such as medical devices, he said.

— Craig Matsumoto, Senior Editor, Light Reading