For silicon controversy, look to Bookham

For a technology platform that everyone wants to shoot full of holes, sounds like Bookham is doing something pretty important.

BY KEVIN SLOCUM AND ROBERT MANDRA

Bookham Technology completed initial and follow-on public offerings of its common stock and introduced a series of planar-waveguide products to the optical communications marketplace last year. Unlike other planar devices on the market that utilize silica waveguides on silicon substrates, Bookham's products utilize proprietary technology to create silicon waveguides on silicon substrates. With this technology, Bookham introduced a number of integrated devices based on its arrayed-waveguide-grating (AWG) platform. Take away the economic market issues, and there probably wasn't a more controversial photonics stock in 2000 than Bookham's. Despite that controversy, the company marched from $6 million in revenue in 1999 to $39 million in 2000.

When the only integrated solution investors were talking about was an AWG for mux/demux applications, the attack on Bookham was that silica is better than silicon. It didn't matter if the company could meet customer specifications. When an optical-channel monitor was added to Bookham's product list, the part was described as nothing more than an off-spec AWG and a bunch of photodetectors, never mind if it met the customer's performance criteria. Then there came the announcement of a "mux VOA"-a multiplexer combined with variable optical attenuators. This device is used to control the output of 40 different channels with a single part. Previously, this function used some sort of WDM module (probably thin-film-filter-based) and 40 separate attenuators. That means the mux VOA consolidates as many as 80 discrete functions in a single device. The next objection? The part wasn't going to matter for a couple of years.

In early January, SDL's PIRI unit announced a mux VOA, and we believe others are heading down this path, as well. We recently spoke with a well-known industry executive who not very long ago thought integrated photonic solutions were far into the future-that story has changed. We told investors at the beginning of our coverage of Bookham that they would miss the story if they focused on the company as an AWG story. In a straight-up comparison, for a singular function, silica solutions will probably win on most performance criteria when compared with Bookham's silicon technology. Having said that, Bookham has attacked all the performance issues and can meet most customer criteria for this device when used in a straight mux/demux application. However, in moving beyond that singular function and doing more complex integration, these competitive knocks begin to fall apart. That is where the game is headed this year.

Investors have ignored the Lucent Technologies mux VOA design win by Bookham, announced late last year. Given Lucent's difficulties, we understand that reaction, but it shouldn't be ignored. First, Lucent may have taken a knockdown blow, but we don't believe for a minute they are down for the count. Second, Lucent has been the largest consumer of AWGs in the world over the past couple of years. The company has had plenty of problems with these devices and is probably the best critic of such a device. Thus, Bookham's design win for the redesigned WaveStar OLS platform says something about the credibility of its technology.

To date, optical systems have been expensively pieced together with a bunch of fairly bulky devices. However, system price performance is coming under pressure as carriers struggle with capital availability due to a challenging pricing environment for services. Carriers need cheaper and more powerful systems. To cut costs in the short term, the components composing a system will need to do more and do it inexpensively. That can be achieved through the integration of today's optical modules into integrated planar devices such as those now being delivered by Bookham.

Innovation is often a risk to all involved, but it is innovation which gives order-of-magnitude price-performance improvements. The economic realities of the carriers, in our view, will push system vendors to more aggressively consider and adopt emerging integrated solutions. We believe the market must move in this direction if suppliers and system manufacturers are going to preserve profitability. We don't believe Bookham will be the only supplier of integrated optical solutions. However, Bookham appears it can play a significant role in this new phase of the optical revolution, and we believe the naysayers will end up owning the stock.

When Bookham announced its accelerated capital expenditure plans last summer, it was a double-edged sword. The good news was the company saw demand requirements that warranted a more rapid expansion of its manufacturing capacity. The bad news was that the burden of that capacity was going to push out profitability. We believe the plans surrounding that accelerated capacity were for a newly built fabrication plant. But last December, Bookham announced it had leased a 150,000-sq-ft wafer-fab facility in Columbia, MD. This facility had previously housed Honeywell International Inc.'s Microelectronic & Technology Center. Once operational, the plant will serve as Bookham's North American headquarters from which it will increase its overall manufacturing capacity and provide technical support for customers. Bookham indicated the facility is a fully integrated design, fabrication, test, and assembly plant that includes offices, a laboratory, and extensive production space. Leasing the facility may reverse part of that profit push-out, because facilities secured in this type of leasing arrangement are typically far less expensive than new builds.

Bookham transitioned last year from a company in the development stage to an early leader in the supply of integrated optical solutions. This year, we believe the company's course will shift from simply sailing into the wind to having the wind in its sails. We expect advanced DWDM products to become the majority contributor to revenue, and we expect Bookham to work aggressively to bring a profit to the bottom line ahead of schedule. We believe investors will see additional design wins by Bookham that will validate the company's solutions and, with that, the controversial nature of the Bookham story will fade. We like Bookham's chances of being one of the best-performing optical component stocks of 2001.

Kevin Slocum is a managing director and communications research analyst for Wit SoundView (Stamford, CT). He has more than 18 years of financial industry experience, including equity research, sales, and analysis. He can be reached at (203) 462-7219 or kslocum@witsoundviewcom.