Telecom's Survivors

06/11/2004 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

"Most of the telecom Class of ’99which were supposed to make us all wildly rich have met their makers," says Jon Markman. "But a few survived and JDS Uniphase and Avanex represent ways to play a version of the 90s 'Big Vision' that is now slowly becoming real."

"Tops on the list is the granddaddy of them allJDS Uniphase (JDSU NASDAQ). Shares of this major maker of fiber-optic components fetched 27 cents, split adjusted, back in 1993, when the Internet was just a gleam in futurists’ eyes, but ultimately went for as much as $153 in March 2000 when the hype was on high heat. That’s a 54,200% gain, in case you were wondering. Then the line went dead. Shares sank to $1.96 again by October 2002, then rallied as high as $5.89 in January before sliding back to the mid-$3 range in recent days. So is the company fairly priced now, or is the stock poised for a return to pennies?

"Strangely enough, JDS Uniphase shares are now compelling. Courtesy of the overbuilding of fiber-optic capacity back in the day, the company now has just a fifth of its 2001 revenues, and revenue for the past nine months is still down over the prior nine months. And prices of the components it sells are still falling. But in its last earnings report, the company said spending by carriers on its type of equipment is finally improving. And it has survived the long and ugly post-bubble period as practically the lone fiber component maker that can deliver almost any piece a fiber-optic switch maker wants to put in a new box.

"Meanwhile, the story to become excited about now with fiber-optic suppliers is a concept called ‘fiber to the premises’. It represents just about the only way that the Baby Bells can battle back against the onslaught of cable companies that have pushed television, broadband Internet, and telephone service to residential customers nationwide. The Baby Bells’ answer to this death knell is the prospect of far faster Internet broadband and video/TV delivery over fiber-optic lines. Currently, the phone company’s broadband solution, called Digital Subscriber Line or DSL, maxes out at about 1.5 megabits per second, though typical speed is around 768 kilobits. That’s generally a bit faster than cable speeds. But fiber optics will boost the speed as high as 100 Mbps, which is fast enough to make speed concerns absolutely a thing of the past. It’ll be nothing to download a feature film. You’ll be skating on air. Cable can’t match it.

"There is plenty of fiber-optic capacity in every major US city. The problem is the cost of digging up roads to drag it from major routes to the streets where people live. Until now, the Bells have been reluctant to foot this cost. But recent indications of a positive regulatory stance from the FCC, plus pure desperation, has finally pushed them forward. In its earnings releases recently, Verizon has shouted to a skeptical world that it has begun the process. Analysts at The Yankee Group believe it. They recently estimated that Verizon will pass more than 350,000 customers by the end of 2004 with fiber-optics capacity, and in five years it expects deployment to reach six million homes, apartments, and businesses, generating $3 billion in revenue.

"With Verizon leading the way, fiber-to-the-premises will help the Bells keep their heads above water, but the phone companies are probably not the investment play. Possibly the best equity play is the beaten-up makers of the components that pump and multiplex the laser beams along the route from carriers’ central office toward the home. And while, JDS Uniphase is probably the main name to watch, also consider photonic-processing component maker Avanex (AVNX NASDAQ). FA Asset Management value manager John LaForge, a big fan of both JDS and Avanex, said their business probably won’t pick up for two quarters, but by then the story will be better known and prices will be higher. ‘Business is turning for these guys, and no one wants to hear it,’ he said. ‘They’ll want to own it when it pops to $5, but down here they think it’s a problem. They’re wrong. There is no problem. Earnings have come in line two quarters in a row now, and they’ve guided up 5% each time.’"

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