Alan "The Hit Man" Greenspan vs. Technology and Venture Capitalists in an economic Death-Match!
Why Optical Companies will emerge unscathed!

by Briton Ryle

The interest rate tide is rising and the Dow indices are buried neck deep on the beach.

I beat the drum for optical equipment last month with APA Optics. This month, I like Precision Optics (POCI-NASDAQ). Precision Optics is a component supplier. They makes the filters that split beams of light for dense wave-length division multiplexing (DWDM).

Not again...
The component market is growing even faster than the system and device market. Lack of production capacity for components has created a situation where components are proportionately more expensive than complete sub-systems.

Any company that has the know-how and the production capacity is forming an optical equipment division. They're coming out of the woodwork. Advanced Lighting, until now a supplier of industrial lighting equipment, just announced an optical component division. And GE has invested in the venture. Simple supply/demand fundamentals are driving this sector. And that creates a sound and potentially explosive money-making opportunity for us.

Sorry Mr. Gore, thank MCI and the Department of Justice for the Internet
When MCI brought an anti-trust suit against AT&T, it was only trying to secure a future for itself. The upstart company had no way of knowing the fallout from dismantling AT&T would spark an epic technology boom.

AT&T's monopoly was government imposed in the first place. So ending it was just a return to the natural order. Once competition entered the telecommunications market, the pace of change took off. Now, the Internet is a fact of life for business. And soon it will be for most Americans.

Money makes the world go ëround
Some credit for the technology revolution also has to go to venture capitalists. Venture capitalists often get a bad rap. They're seen as reckless, predatory, even immoral. But Sherman Fairchild's cash helped develop the silicon semiconductor, and Hambricht and Quist put up the dough needed to bring the microprocessor to market. Venture capital has remained a driving force in technology since the Sixties.

In all, venture capital investments totaled US$48.3 billion in 1999, up 150% from 1998. And Internet related companies accounted for 66% of venture capital. All tech companies have to do is ask, and the VCs fall all over themselves to be first in line.

The Wealth Effect
Investors have responded to the neck-snapping growth of technology by ramping up stock prices. Life is good, sell a little AOL, buy an SUV. The wealth effect from the stock market is driving the economy, something like two-thirds of GDP is spending.

Outstanding margin debt on the NYSE hit US$243 billion in January 1999. And cash flow into OTC stocks boomed nearly 250% in three months, from US$9.3 billion in Nov. 1999 to US$24.3 billion in Feb. 2000. I can see why Mr. Greenspan might be a little nervous.

The Real World
As a tech investor, I'm still not really sympathetic toward interest-rate sensitive stocks. But my wife and I are buying a house, so I've developed a more personal relationship with Mr. Greenspan's policies. (Let's just say he didn't buy me dinner first). When Greenspan says that the economy is moving too fast, he's talking about the wealth effect, spending, and the Nasdaq.

Because stock is currency. Venture capitalists gladly give companies money for stock. As much money as it takes. Sure, so maybe the VCs initial loans cost a little more. But watching the 2 million shares you bought for a dollar close on IPO day at US$60 makes up for it. And then some.

The Reverse Flying Two-Handed Eye Gouge!
Alan Greenspan is trying to attack the problem head-on, i.e., the money supply. But rising interest rates won't slow down the venture capitalists. The rewards are simply too great. And besides, the ultimate source of venture capital isn't personal fortunes or bank loans. It's the investor.

I'd like to offer a solution. I advocate the immediate cancellation of any form of capital gains tax and termination of all margin buying. The capital gains thing is just a matter of principle, and will never happen. But if you want to soak up some excess capital, take it from the source. Make people play with their own money, tighten margin requirements.

My-Optic viewpoint
Rising rates or not, capital will gush into tech for the foreseeable future. And it's going to gush into the areas with the most demand from business and consumers — the Internet and wireless. The most mission-critical area of both sectors is the network. Optical networking will increase data traffic exponentially, and do it much cheaper than Sonet equipment.

I believe huge demand and near-open access to venture capital makes optical equipment companies less sensitive to rising rates. And Precision Optics stands out in the sector. POCI has a decent cash position and virtually no debt, a bonus, with Greenspan on the prowl.

Precision Optics — The Three Ps
But the best thing about POCI is its technology. Filters for DWDMs are the components that split a light wave into separate colors. A sensitive, thin reflective film is used. The film has to be heat resistant. None of this is easy to do.

In fact, optical components are in such short supply that systems suppliers are signing long-term contracts with component makers to ensure that they get what they need. Sometimes the systems suppliers go so far as to pay the initial cost of filter manufacturing for the right to purchase the products.

Last of the Independents?
POCI is one of the few remaining independent manufacturers of thin-film filters for DWDM devices. In fact, there are only six companies who make thin-film filters — E-Tek, JDS Uniphase, NetOptix, Corning, and Precision Optics. To gauge the value of such companies, take a look at Optical Coating's recent merger with JDS Uniphase. Investors made out like bandits.