The three kings of optical components: Avanex, Bookham and JDSU

The fiber-optics downturn after the start of the century shook the industry to its core. Companies like Avanex and Bookham quite literally were fighting for their lives, and JDSU was but a shadow of its former self. All three were struggling mightily against miserable, sometimes negative margins, eroding prices, high labor costs, and too much competition.

Yet it was their faith in the fiber-optics industry and their investment in that industry at a time when things seemed darkest that has propelled these companies into a leadership role today. It would have been easy for them to have said that fiber optics was “dead in the water,” as several financial analysts had concluded, but that was not the conclusion these vendors were ready to draw. Rather than throwing in the towel, each in its own way decided to wait for better things. Each has begun to be handsomely rewarded for that perseverance, and we believe they will continue to reap enormous benefits in the future as the industry improves.

A number of things have occurred to dramatically alter the picture since the dark days, things that have left these three companies in an advantageous position in terms of optical component production and that provide them hope for a flourishing tomorrow.

First of all, the entire infrastructure of the optical components market changed. The major systems houses, which heretofore had their own “captive” optical components suppliers, came to the realization that they would do better ridding themselves of such operations and selecting optical components on the open market.

Thus, Lucent let go of Lucent Microelectronics, Nortel got rid of Nortel Opto, and Alcatel let go of Alcatel Optronics.

What was wrong with the captive suppliers? They seemed to have all the benefits necessary for success. They had guaranteed business from the systems divisions within their parent companies, as well as the freedom to garner whatever outside sales they could generate. It seemed like a win-win situation.

There were two major problems. First, the parent company had to purchase devices from its optical component subsidiary at prices high enough to keep that operation in business. These rates were sometimes higher than the prices they would otherwise have paid on the open market. Second, other systems providers were suspicious of the captive suppliers, afraid that if they did business with them the component company would relay proprietary information to its “owners,” which were often competitors with the company placing the order.

As the result, captives began to lose their glimmer and systems vendors found themselves doing business more and more with independent suppliers. These concerns had been factors in the past behind the enormous success that JDSU had enjoyed and would continue to work to that company’s benefit.

Cementing the doom of the captives, and forcing their parent companies to sell them, were the overall souring of the fiber-optic market and the impact of offshore, low-end labor costs. Major vendors could no longer afford to drag around loss-generating captive suppliers, which were facing diminishing demand for their products and offering higher prices than their parent companies could achieve elsewhere.

It was in this environment that Avanex and Bookham saw an opportunity.

Avanex had been a small, California-based provider of subsystem and optical components equipment. When it purchased Alcatel Optronics and Corning’s optical component division in 2003, the company inflated its size and acquired a variety of product lines it had not earlier possessed. The deals also provided it with many new opportunities and challenges.

Likewise, the very complexion of Bookham changed when it purchased the captive optical components arms of both Nortel and Marconi. Like Avanex, it inherited the business but also many of the problems of the captive companies.

Taking over the captive businesses of Nortel and Alcatel, respectively, have become enormous advantages for Bookham and Avanex. The new assets have provided them with stability and a greater percentage of the overall market. It separated them from other, smaller niche independents that often were acquired or simply went out of business. It gave them far broader product offerings to appeal to more clients around the world.

However, with these acquisitions came challenges, many of them the same ones that caused the parent companies to divest. The margins were often lousy, the products were sometimes legacy-based, and the cost of making the products was high.

The result was that they had to begin coming to grips with these problems in order to survive and eventually become profitable. While revenues increased and continued to grow, both Avanex and Bookham found themselves in a position where they had to lower the “burn rate,” or their overall operating costs. This meant quickly sending their manufacturing to lower-cost countries and vastly reducing experienced workforces in developed nations. It also has meant developing new products and trying to wean their major customers off the legacy gear that provided poor margins and got in the way of their own growth.

These tremendous challenges are being addressed successfully. Bookham in its most recent quarter ended Sept. 30, 2005, was EBITDA positive for the first time in its long history. Avanex is in the process of reducing its burn rate by $10 million to $12 million per quarter and looks to achieve profitability in the near future.

C. David Chaffeehas participated in the fiber-optics industry since 1983. He currently directs a small company, Chaffee Fiber Optics, which is publishing the complete “Three Kings of Optical Components” report, from which the above is excerpted. He can be contacted at [email protected] and (410) 750-1406.