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Get on the Bandwidth Bandwagon with this small-cap play on the Optical Revolution!
by Briton Ryle
For want of a nail the shoe was lost, for want of the shoe, the horse was lost. And for want of one product, US$64 billion in market cap was lost.
It's called a Dense Wavelength Division Multiplexer (DWDM). It splits the colors in a light-wave into individual, unique wavelengths, or channels. It's the most important advance in optical networking and a godsend for cost-conscious, bandwidth-hungry companies. And Lucent can't make enough of 'em.
The telecom equipment giant warned that earnings would be missed. The stock got hammered, dropping US$64 billion in market cap in a single trading day. But there's always an upside.
Lucent failed to anticipate the demand for their new DWDM products. Demand for DWDM products is far outstripping supply. And one company is particularly well-positioned — APA Optics (NADSAQ:APAT). APA just announced two revolutionary DWDM products. And when word gets out, APA will explode to the upside.
If you've paid any attention to tech stocks over the last year, you know about optical companies, like JDS Uniphase or Sycamore networks. You've also seen their valuations skyrocket. JDS boasts a market cap of US$58 billion on US$673 million in sales. Sycamore's market cap is US$23 billion on only US$30 million in sales. Clearly, the market sees a bright future for these companies.
Sales estimates for the optical equipment sector range from US$17 billion to over US$40 billion by 2003. International DWDM sales should hit US$3 billion by 2004. Another forecast sees domestic DWDM sales going from US$2.1 billion in 2001 to nearly US$6 billion by 2006.
Buy or die
The story behind most booming optical equipment companies is growth by acquisition. Over the last few years, the pace of technological innovation has been blinding. One lapse in strategic judgement can put a company out of the running. Often, there's no time for R&D. To keep up, companies have to buy or die.
JDS Uniphase, Nortel, Cisco, and even Lucent have been on the acquisition warpath. Cisco alone spent US$9.5 billion on optical companies in recent months, including US$7 billion on Cerent, which had only US$10 million in revenues. CEO John Chambers said Cisco plans to buy at least another twenty companies in 2000. Interestingly, Cisco doesn't have DWDM technology. Yet.
JDS bought Uniphase for US$6 billion and dropped another US$15 billion on E-Tek Dynamics. The trend toward consolidation and insane valuations will continue. Why?
Because many believe the optical industry will bury all other network technologies in as little as two years.
Who's your Daddy
It's ironic that Lucent often gets painted out of the optical landscape. After all, Lucent is the father of fiber optics. Two scientists, Arthur Schawlow and Charles Townes, at Bell Labs (now Lucent's R&D division) got a patent for their laser design. And Bell Labs now holds over 2,000 patents for optical technology.
Lucent may have lost a battle, but I don't see the company losing the war. Lucent has a huge lead in market share, having sold US$6 billion in optical equipment and fiber in 1998. Compare that to JDS sales. And the Ortel acquisition will put them into the voice over cable market as well as adding some nifty optical technology. You can bet that recent problems will not be soon forgotten at Lucent.
But here's the kicker. I've heard there's a chance Lucent may issue a tracking stock for its optical division. That stock would unlock billions in value. It'll probably be worth US$200. Due to current market weakness, I see the bottom of Lucent's slide in the US$45 range. Lucent is a strong buy at these levels.
But I'm not here to talk about Lucent.
Less is Moore
The computer revolution happened as fast as technological innovation would let it. Moore's Law observes that the processing power of electric circuits doubles every 18 months. While that's plenty fast for most people, you ain't seen nothin' yet. Optical processing speeds are growing four times as fast.
DWDM increases network capacity exponentially by sending several light-waves down one piece of fiber. Bandwidth can potentially be increased ten times over. And the amount of equipment needed is actually much less than for current SONET (synchronous optical network) networks.
Dense wavelength division multiplexing is a disruptive technology — it does more with less. Disruptive technologies greatly lower costs for businesses and consumers. Vastly cheaper equipment, in turn, can quickly turn an industry on its ear.
APA Optics' newest DWDM is a breakthrough among breakthroughs. It's the kind of thing that gives the pocket protector crowd nocturnal emissions. But it should cause equal excitement in investors.
Networks: The Basics
For decades, analog voice signals were changed into electrical signals so they could move over copper wires. With fiber, voice signals could be converted into light waves and sent long distances very fast. And very cheaply.
Fiber networks come in two basic types: the long-haul, or point-to-point, and the metro ring. Long-haul, point-to-point networks are just what they sound like. They're the long-distance networks, like what MCI uses. And MCI uses DWDM in about 80% of its long-distance network, as does Sprint and AT&T.
Voice and data are generated at one point and travel across the network to another point, where it's delivered to its intended recipient, the end-user. Getting to the end user requires the signal to travel over the local metro fiber ring and, often, copper wires.
Voice signals are small enough to travel over copper with no problems. But copper is no match for the massive data transfers made possible by the Internet.
For data to the home, DSL and Cable access have proved good enough. But the bread and butter for voice and data carriers comes from business customers. And the business customer presents special problems.
Getting enough fiber
What's called a fiber ring is used in urban areas. The idea is to build a fiber ring or loop around a city. You want to get it as close to concentrations of businesses as possible. That way, when a company signs up for data services, it's easier to string a piece of fiber from the ring to the business.
Taipan leases a T-1 line, about the fastest data rate you can get. I'm not allowed to tell you how much it costs, but DWDM will slash the cost. Maybe as soon as a year from now. Here's how.
DWDM divides a light wave into several wavelengths, each of which can carry data. Commercial products now generally use eight or sixteen channels (wavelengths), though it's possible to get more. Lucent's Wavestar has 80 channels, but it's for long haul networks only.
Each channel is either 200GHz or 100GHz wide and can carry 2.5 gigabits (giga = billion) of data per second. APA is ready to roll out a product that creates channels only 50GHz wide, effectively doubling the number of wavelengths that can travel on a piece of fiber. At the moment, this is a unique product. No one else makes one.
Other companies have announced DWDMs similar to APA's. Cash flush from a recent IPO, a company called Avenex says it'll have one ready sometime in late summer or fall. APA is ready to fill orders now. And APA can make the devices themselves in their own factory. APA has a huge first-to-market advantage. They are positioned to dominate a crucial area in one of today's hottest technology sectors. To the victor go the spoils.
A new lease on data
It won't be long before the whole revenue model for data services changes dramatically. DWDM is paving the way for truly customized pricing plans. It will no longer be necessary for a company to lease a T-1 line. Several companies will share one piece of fiber. Within a year, companies will purchase only the bandwidth they need, and they'll be able to pay on a time-based scale.
This has even greater implications for the campus or multi-tenant office building. In the office building, it won't be necessary to run a separate line to each business. And campus networks can be built cheaper and operate more efficiently.
APA Optics is in the right sector, with leading technology. Optical equipment is efficient and promises significant costs savings to carriers and end-users alike. Demand for bandwidth is strong. There's only one question — Can APA Optics execute when orders start coming?
The Golden Parachute
Two decades of being a research facility makes this an important question. Can scientists transform themselves into businessmen overnight? It doesn't matter. APA has a golden parachute — the buyout. I believe the pace of consolidation in the optical equipment sector makes APA Optics prime target number one for acquisition. The big players simply can't afford to miss an opportunity.
In fact, APA CEO Anil Jain has already said that he'd sell the company. It's practically a written invitation. APA Optics stock has put on a great show over the last few weeks. Investors hungry to get into a reasonably priced optical stock bid the stock up to around US$55 a share.
While doing my research I was afraid it was going to get out of range. Fundamental market conditions coupled with profit-taking have caused a retracement into the US$40 range. I would love to get this stock under US$40, but that may be wishful thinking.
The market cap is in the US$350 million area. If APA gets treated like other optical stocks, it will have a billion dollar cap in no time. Upside for us could approach 200%. I will put my buy target for APA Optics (NASDAQ:APAT) at US$47. Please consult the Taipan website if conditions change dramatically. Contact information: APA Optics 2950 N.E. 84th Lane, Blaine, Minnesota 55449 Phone: (612)-784-4995 On the web: www.apaoptics.com.
Here's to Dim G-men and cyber-terrorists
A CIA director gets careless with some sensitive files, some punks attack Yahoo and eBay and boom, SafLink (NASDAQ:ESAF) tacks on another 50%, for a total 200% gain since January. Gotta love it. There's always opportunity in seemingly bad news. Finding it is Taipan's mission, our quest.
I'm really looking forward to SafLink's next earnings report. I think there'll be some positive surprises.
Is No News really good?
I'm starting to get a little antsy with Ashton Technology Group (NASDAQ:ASTN). We're up around 50% to date and the stock is holding up well. But there should be news. Ashton is supposed to be deploying its electronic commerce network this spring. I expected to see some press releases about it by now.
Earnings were released on Valentine's Day. Ashton showed a US$.02 cents a share profit, compared to a US$.22 cents loss in the same quarter a year ago. The gain comes from sale of warrants for subsidiary Gomez Advisors. Ashton is no longer the majority owner of Gomez. There was no important mention of the eVWAP system. I don't believe the stock will stay in the US$10 range without any news. To lock in gains, I recommend applying a mental stop at US$9.50.
Nothing wrong with taking profits
Geoworks (NASDAQ:GWRX) has returned 400% for Taipan subscribers since the beginning of December. Recent news indicates that WAP Forum members are prepared to honor Geoworks' intellectual property rights claims. The stock didn't move much in response, which makes me think we're at the upper end of the medium-term range.
I'm inclined to take profits at these levels. The real work is ahead for Geoworks and the stock has exceeded all of my expectations. I'm setting a price target of US$45 a share. When this target gets hit, we'll put those profits to work somewhere else.
Correction: I mistakenly wrote that Cisco does not have DWDM capability. Cisco recently purchased Pirelli's optical division, giving them a DWDM product for long-haul networks. I mentioned Cisco as a potential buyer, and I still believe this to be valid. The Pirelli purchase puts Cisco in the long-haul DWDM market, but it still doesn't have anything for the metro, local area network (LAN). APA Optics products are targeted at this market. Sorry for the confusion.
I will be attending a huge wireless conference in New Orleans from Feb 27th through March 1st. Of course, I'll be looking for some explosive wireless investments. Please stay in contact through the web site and the hotline for anything I may uncover.
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