Wait till next year

Dec. 1, 2007

by Stephen M. Hardy

I used this space in February to proclaim 2007 the Year of Making Money. Given the increasing health of the optical communications market, it seemed time for companies in the optical communications space to either put up or shut up-turn a profit or turn in your badges, preferably (for the investors’ and shareholders’ sakes) via the sale of the company. Thus, 2007 wasn’t just going to be the Year of Making Money. It was also the Year of Consolidation, I asserted.

Now that 2007 has reached its final days, I can say that, at least on one level, I was right about this being the year to make money (once you survived the onset of lean inventory practices, anyway). The Dell’Oro Group estimated last month that the optical transport equipment market will prove to be $2 billion larger this year than in 2006. Infonetics Research, meanwhile, says that the second quarter of this year was the optical systems market’s largest since 2001; in fact, the market overall this year will be the healthiest it has been since 2001, Infonetics adds. Ovum RHK agreed, saying that second-quarter optical transport sales increased 14% over the previous quarter and 20% versus the same quarter last year. Dittberner, meanwhile, has predicted a record year for PON shipments.

Thus, the evidence so far suggests that the kind of environment necessary for profitable operation has been created. The question, then, is whether companies operating in the fiber-optic space have taken advantage-either by getting their numbers into the black or selling off to someone with newly deepened pockets.

At the systems level, recent results look mixed. Alcatel-Lucent has struggled somewhat overall, but not within its optical portfolio-its third-quarter results showed strong growth across the board. Nortel’s third quarter showed revenue declines quarter-on-quarter and year-on-year in long-haul optical but an up-tick in metro optical. Ciena, on the other hand, reported healthy growth quarter-on-quarter and annually in the third quarter.

The subsystems and components space also has shown a lot of ups and downs. JDSU suffered an overall loss in the first quarter of its 2008 fiscal year, but exhibited quarterly increases in non-GAAP revenue for its Optical Communications and Advanced Optical Technologies segments. Finisar, however, pre-announced second-quarter 2008 revenues below both the prior quarter and year-on-year. It expects revenue growth to resume in the third quarter.

But most eyes have fixed on Avanex and Bookham, two companies I called out by name in my February editorial. Both companies have made headway. Avanex announced first-quarter fiscal 2008 figures that showed net revenue increases over the previous quarter and the same quarter last year-and a net profit of $45,000. Bookham, meanwhile, wasn’t lucky enough to make a profit in the same quarter but posted revenues above both guidance and the previous quarter. Both companies lost money during their 2007 fiscal years but significantly decreased the total loss from fiscal 2006.

Despite such moral victories, it is clear that the rising tide has not fully floated all boats, even if some companies have swum nearer to the surface. And on the face of things, that should mean that more companies should be looking to cash out.

However, the M&A activity we’ve seen this year doesn’t follow this logic. The Alcatel-Lucent pairing certainly seems a good move (for Lucent, anyway) but is complicated for our purposes by the fact that the companies aren’t pure-play optical systems houses. The same can be said for Nokia Siemens Networks. Meanwhile, it seems what consolidation did occur in the optical communications space at the components and subsystems level mainly involved profitable companies, i.e., Oplink’s purchase of the healthy OCP and MRV/LuminentOIC’s acquisition of (the believed healthy) Fiberxon.

Which is the way M&A works these days. The irony of the stay-or-go decision that I called for earlier this year is that a company has to be profitable to be considered an attractive acquisition target. (See “How to be Acquired,” Lightwave, August 2007, page 35.) In other words, that rescue craft won’t arrive (it won’t even be sent out) until the flood waters have receded and you’re no longer in need of assistance.

But the ordeal of clawing to the water’s surface will no doubt prove as much as many companies (and their executives) can handle. So with a few more companies reaching profitability, I expect that we’ll start seeing a lot more consolidation next year, with some companies getting out while the getting is good and others holding fire sales.

Next year should prove to be the Year of Making More Money-or Just Enough Money-to make 2008 the time when consolidation finally starts taking hold.

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