Fiber optics: A light still shines … distantly

The lights went out on fiber-optics stocks more than a year ago, but according to analysts, it’s only a matter of time before they shine again.

Considered Wall Street darlings even after the dot-com crash, the stocks have been sucked into a black hole largely because of major cost cutting by telecom giants, those analysts say.

While long-term prospects are still good, don’t expect prices to begin recovering before the middle of next year, the analysts add.

Just last week, Morgan Stanley Dean Witter & Co. cut its ratings on many companies in the sector, including such big names as JDS Uniphase Corp. (JDSU) and Nortel Networks Corp. (NT), to “neutral,” from “outperform.”

The New York investment bank says it expects a rebound in the sector to come as late as the third quarter of 2002.

But analysts also say that investors should view both fiber-optics component and equipment manufacturers as smart long-term stock plays.

“We’re moving to a fiber-optics world,” says Mark Storm, an analyst with Frost & Sullivan Inc., an industry consultant in Norfolk, Va.

“Fibers will replace wires as a way of moving information around,” he says. “Nothing is changing that trend.”

Fiber-optics technology basically allows data to be transmitted in light pulses contained within insulated glass material. The associated big bandwidth makes it ideal for sending large amounts of data.

Hailed as the next great means of data transmission, fiber optics became hot as companies rushed to Wall Street over the last couple of years. Investors quickly followed.

Now the sector has fallen from grace.

For instance, JDS, based in San Jose, Calif., is trading in the $17 range, down 88% from its July 2000 high of $140.50. Nortel in Brampton, Ontario, is trading around $13.50, an 85% drop from its July high of $89.

buying in

Analysts blame the drop largely on decisions by big service providers – companies such as Sprint Corp. and WorldCom Inc. – to rein in capital expenditures after spending so much on fiber optics.

“The providers gave the ammunition to [fiber-optics] equipment vendors to project that their business would grow quickly and revenues would grow to [large] amounts,” says Andrew McCormick, a senior analyst at the Aberdeen Group Inc. in Boston.

Then, say Mr. McCormick and others, investors bought into the growth and bid up the prices.

“The valuations were exceptionally high,” says Mark Lutkowitz, an analyst with Communications Industry Researchers Inc. in Charlottesville, Va. “It was inevitable the prices were going to come down.”

Last summer, even as skepticism had set in about high-priced tech stocks and the feeding frenzy on dot-com issues, fiber-optics stocks were still climbing. Even the new companies going public were hot items.

For instance, Corvis Corp. (CORV), an optical networking company in Columbia, Md., priced its offering last July at $36 and closed its first day of trading at $84.72, a one-day gain of 135%.

Today, its stock hovers around $6, not much higher than the 52-week low of $4.69 it hit April 3.

The question now is, when will stocks such as Corvis go back up?

Aside from a slowdown in telecom spending, some industry observers have pointed to too much capacity for too little demand.

But many analysts say that’s hogwash. They say that laid fiber networks sitting idle are simply potential, not current, bandwidth.

“Why was [fiber] lying in the ground not a bandwidth glut during the fiber-optics craze, and it is now?” wonders Mr. Lutkowitz. “It just makes economic sense that if you’re going to lay the stuff, lay more for the future.”

He points out that only a fraction of the buildings in the United States are hooked up to fiber networks, which now reach into most metropolitan areas.

“If only 3% to 5% of buildings have access to fiber, we’ve really only just begun to take advantage of [the technology],” he says.

Avoiding the duds

Of course, the tricky part will be picking which companies in the sector are survivors and avoiding those that are duds.

“The market has some long legs,” says Mark Langley, an analyst with Epoch Partners in New York. “But arguably, there are too many companies out there.”

Long-term favorites among analysts include equipment providers Ciena Corp. (CIEN) in Linthicum, Md., Tellium Inc. (TELM) in Oceanport, N.J., and Sycamore Networks Inc. (SCMR) in Chelmsford, Mass. Also among the favorites are Nortel and Corvis.

Corning Inc. (GLW), a Corning, N.Y., company involved in both equipment and components, also is a long-term favorite.

Components manufacturer JDS also made the favorites list, although some analysts warn that the company faces a challenge in integrating its new units after going on the acquisition trail over the last several years.