Reality comes from customers

Sept. 1, 2002

We're wondering when you expect your business will show signs of recovery.

By Kevin Slocum

We want to try something different this month and take advantage of the collective knowledge of Lightwave's readers and those who devote a few minutes to our monthly writings. For years, SoundView Technology Group has prided itself on research that is at least in part driven by user feedback. The basic premise being that you can't trust a competitor's read of another competitor and you can't trust management. The only one you can trust is the customer that buys the product. That approach grew out of the company's original founding roots as a division of Gartner Group.

Gartner gathered user inputs every day and made it the basis for an information technology advisory service for corporations. In its early years, management at Gartner felt the same user feedback that helped guide other users to good products and away from bad ones could be packaged in a way that was useful to investors. That unit of Gartner became the independent company that is now called SoundView. Up to this day, SoundView enjoys a close working relationship with Gartner that helps support our research efforts for the technology requirements of corporate enterprises.

However, the telecommunications carrier markets are not ones where Gartner has made its name and most of the user feedback we come across today comes from a base of contacts we have built over the years through conference attendance, cold calls of people named in trade publications, unsolicited reactions to our research writings and, frankly, this column. We began writing for Lightwave in the middle of 1999. More than three years later, we can say that some of our best input and food for thought have come from Lightwave readers.

We are bearing down on 2003. Our own view is that the telecom business and the stocks of the companies that participate in the sector have bottomed out. Bear in mind that it is mid-July as we write this column. We don't see things taking off to the races, because so much still needs to be fixed. We are more curious though about what readers from industry think, so we want to encourage you more aggressively than normal to please give us your feedback.

The types of things that we tend to be most curious about are how far along in the inventory liquidation process we are-everywhere from the component level to carriers. What sort of customer activity are you seeing? For instance, we had a recent conversation with a subcomponent supplier that is now seeing steady orders, albeit at one-10th the pace of the peak rate. We are also interested in the relative strength of different suppliers. On this point, the vendor that seems to have the most uncertainty among the majors that we encounter today is Nortel Networks. Most industry participants say they are not seeing Nortel in the market. Conversations about Lucent Technologies several months ago might have generated the same sort of comments, so this may just be an outgrowth of where Nortel is in its cycle of redirecting its optical-system efforts. For our part, we want to know what a broader set of

Nortel customers have to say about the matter.

At a very high level, we wonder whether you think the business has bottomed out, and if so, when you would expect your business to show signs of recovery and just how meaningful a recovery. There are a lot of questions, and we do not want to turn the column into something Lightwave's editorial staff did not intend. But we are through the better part of another dismal year for the industry and the type of things we are seeing in the news would have you feeling there is no hope for health anytime soon. The picture of a grizzly bear gnawing at a stock chart this morning made us feel it might be time to trawl for a bit of good news among the bankruptcies and book cooking. We will share what we learn where conclusions can be reached without hurting the sources.

Industry restructuring
Switching gears, the restructuring of the industry seems to be gaining momentum. Sycamore in fact decided to exit the transport equipment business to focus on its switching platforms, as we had suggested some months earlier. Level 3 got funding from a group of investors for the express purpose of taking advantage of distressed assets. One trade publication downplayed the development, because management said it was not interested in network assets, just customers. If that is what Level 3 needs to get healthy, we'll take it. And Nortel said it was exiting the optical-component business.

The rumors of additional industry developments have begun to circulate faster and more furious these days, and while some are far-fetched, we think you will see a steady diet of combinations and or graceful exits over the next 12 months. One rumor has been that Intel was interested in JDS Uniphase. That rumor drew an "in my dreams" reply from one of our JDS sources. We have written that if GE was truly interested in Lucent's fiber operations when they were put up for sale, then they should consider Corning. Since that time, we have had more than one input that there might be some truth to our line of thinking. Intel is rumored to be serious about some portion of the Nortel component assets. SBC Communications is said to be interested in Qwest's backbone network.

Building on rumors
As we have said in the past, any one of these rumors coming to fruition by itself may not be a profitable development for investors, but over time they will move the industry to a healthier position. That will ultimately make investing in the sector a profitable experience again.

Last month, we showed you a graph that took U.S. telecommunications equipment spending away from wireline carrier capital expenditures. We highlighted the much higher rate of decline in non-telecom equipment spending. We said that we would attribute the spending to network construction, computer equipment, software, and services. There was another category of spending that we didn't know about that helped that line perform much better than telecom equipment spending over the past seven quarters. It was the fraudulent booking of non-capital expenditures through the capital-expenditure account. We'll only know how different the data will look when we get fully restated figures from WorldCom and whoever else chose the same path.

Kevin Slocum is a managing director and head of communications research at SoundView Technology Group (Greenwich, CT). He has more than 20 years of financial industry experience, including institutional equity research sales and analysis, and has been named to the Wall Street Journal's prestigious "Home Run Hitter" list two consecutive years. He can be reached at 203-321-7200 or [email protected].