Surviving The Telecom Bubble (GLW, CIEN, JDSU)

By Dean Lundell | May 29, 2007 AAA

There is a very simple concept in telecommunications: you can put more data (information) on a beam of light than you can on a radio wave. A few years ago several companies all tried to take advantage of this simple principle at once, and the "telecom bubble" was created. We're going to shine some light on three that survived that bubble and now supply optical equipment from one end of the globe to the other.

Patently Clear
Corning's (NYSE: GLW) growth and current financial well being stem from its flat-panel, liquid-crystal-display (LCD) business. Between televisions, computer desktops and notebooks, and other applications, the company commands 50% of the market. LCD's account for approximately 40% of its revenue and 80% of its profit. The company expects demand for LCD's to grow by 32% per year, over the next few years. To meet that demand, GLW is investing $150 million to expand its production capacity in the form of a new plant in Japan.

However, it's this investment that worries some onlookers, as this is exactly the kind of expansion that led to over capacity, which in turn fueled the telecom bubble. Corning is aware of the threat and is trying to balance capacity with demand in what can be a very volatile market place.

GLW is very exposed to that supply/demand equation. Half of its sales come from just 10 customers. This kind of outside leverage and demand volatility causes many investors to shy away from the stock, despite the company's year-over-year financial results of 208% growth in earnings per share versus a loss and a return on equity of over 28%.

Corning's leverage on the plus side is its R&D and expertise in not only LCD's but also in fiber optics and related equipment. To meet the demand of internet and video applications, Telecommunications companies are bringing fiber-optic technology closer to the end user. Corning is a low-cost producer after its post-bubble restructuring, and there is one over-riding reason that the company is the market leader - it owns the patents on much of the technology. (To learn more, see Buying Into R&D.)

Buying Bandwidth
Ciena (Nasdaq: CIEN) is also the beneficiary of telecommunication and cable carriers beefing up their optical capability and buying additional bandwidth. Improving market dynamics and a cost-deduction restructuring have enabled Ciena to return to profitability despite the rather volatile demand it has seen. Despite being a relatively small participant in this market with only a 10% market share, the company is positioned as a technological leader and derives approximately 80% of its sales from optical equipment.

In an effort to be a long-haul provider, Ciena has recently acquired vendors Photonics and Catena, and it has an appetite for more. Ciena also has leverage issues stemming from a small customer base. Because of this, it is conceivable that Ciena could be end up an acquisition target itself. It doesn't help that, although Ciena spends a great deal on research,so far its results are thin with a net margin of 2.9% out of a gross of 46.2, an operating margin in the minus category and a rather paltry return on equity of 2.4%.

So far, Ciena's technology and R&D edge along with the increased demand for bandwidth has allowed it to compete. However, at 143-times earnings, investing in this firm is not for the faint of heart.

Still on the Bubble
Despite the resurgence in demand for fiber optic bandwidth, JDS Uniphase (Nasdaq: JDSU) has still not returned to profitability. During the telecom bubble, JDSU used its lofty stock price to make several acquisitions. The result was a very broad suite of products.This made the company a one-stop-shop for optical-equipment manufacturers - a vendor for the vendors.

While conceptually intriguing, financial results have not materialized as yet, with no net earnings, a -4% net margin on a gross of plus 36% and a return on equity of -3.3%.

Looking ahead, JDSU's 2005 acquisition of Acterna, with its testing equipment products, gives JDSU the visibility it craves and the (45%) sales its needs. JDSU's prospects should improve given the current demand for bandwidth - which will in turn generate a concurrent need for testing equipment. One has to hope its cost restructurings will help it service the debt on its $375 million convertible offering without diluting the hoped for earnings too much.

An Illuminating Experience
This is one of those businesses where a fundamental tenant is: pay me now or pay me later, but in the end you're going to pay me. However, when the major telecoms and cable companies all try to get through the gate at once, boom-and-bust cycles are the result. This is a market where an investor's patience could be tried, and should you choose to invest in these any of these companies, please remember the last time we had a bubble.

To learn more on market disasters, see The Greatest Market Crashes.

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