Shrink resistance

by Stephen Hardy

An enduring theme among analyses of the optical communications space is that there are too many companies. We hear this complaint most frequently about component and subsystems vendors, whose margins generally have remained anemic for the last decade. But the same sentiment also covers systems vendors, whose margins have waned over the last several years as well.

Executives at several of the companies in question have expressed similar opinions about overpopulation in the optical ecosystem. So if everyone is in agreement, why hasn't the industry reshaped itself?

It's not that mergers and acquisitions haven't taken place. We saw JDSU reach the top market share spot in part due to a series of acquisitions during the bubble years. However, Finisar became the new king of the hill a few years ago, thanks to its acquisition of Optium, among others. Then JDSU dropped to third last year when Oclaro and Opnext merged. These, of course, are the most salient examples of M&A; there have been plenty more. For example, we've seen Cisco acquire CoreOptics and Lightwire, triggering speculation that systems houses might be engines of consolidation. Alcatel-Lucent's acquisition of Capella might confirm this trend.

The systems level has been quieter, with Ciena's purchase of bankrupt Nortel's optical business the most notable deal. Perhaps the most interesting catalyst to watch in this niche is Marlin Equity Partners. The private investment firm has reached purchase agreements for Nokia Siemens Networks' optical business and Sycamore Networks and indicates it's not done yet.

So we've seen plenty of M&As over the last several years. So why is the space still considered too crowded?

First, "the right size" of the market keeps changing -- not because there isn't a demand for optical technology, but because the money spent on the technology isn't growing as rapidly as the cost to produce it. That's why margin improvement remains problematic.

Second, the investment required to fund an optical technology company is significant -- and investors want their money back at a profit. A distressed optical technology market is like the mortgage crisis; those who bought when the market looked particularly promising may now find their investments underwater.

Contrarily, the third reason is that despite calls for companies to leave the market, new ones keep entering it. The success of such young companies as Acacia Communications shows that, in a market that's technology driven, the right idea can still make money. And we should brace ourselves this year for buzz around a wave of startups focused on component level integration strategies and photonic integrated circuits.

In short, despite what outside observers would say is an obvious problem, the optical communications market has proven stubbornly shrink resistant. And I don't see that changing anytime soon.

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