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Add a little more fiber to your portfolio with Luminent, Inc., and let the profits shine!
by Siu-Yee Ng
Within the last decade, we have seen the communications network undergo major (r)evolutions. The original purpose of network infrastructure was to deliver voice traffic. But with increased use of the Internet and other data-intensive applications, the original communications network has met its match. This has driven service providers to invest significant resources in new network infrastructure, and communication equipment vendors to rapidly upgrade equipment to provide greater network bandwidth and increased transmission speeds.
Ryan, Hankin & Kent, a research firm, believes that Internet and other data traffic will increase by more than 4000% between now and 2003. To meet this demand, service providers are scrambling to lay fiber optic networks. This technology involves the transmission of data via pulses of light in optical fibers, and provides higher quality and greater bandwidth over longer distances than traditional copper wire.
The proliferation of fiber optic networks has generated significant demand for singlemode fiber optic components and subsystems. These are split into two broad categories: active and passive components. Active components are the core technology for optical networks, requiring some input of power to generate, boost or transform optical signals. Passive components are used to direct, split and merge optical signals without the use of electricity, and are necessary for wavelength division multiplexing (WDM) systems.
The Multimedia Telecommunications Association, a market research firm, estimates that communications service providers worldwide invested approximately US$33 billion in network infrastructure in 1999. Despite the aggressive deployment of optical infrastructure, data traffic growth continues to strain available capacity. Given the extreme cost and time involved in laying additional fiber over long distance networks, service providers seek component solutions that maximize utilization of installed fiber optic networks rather than replacing or adding to them.
WDM enables service providers to increase the capacity of their existing optical networks in a cost-effective manner. It is used to separate or combine light of different wavelengths or colors, increasing capacity by enabling simultaneous transmission of data along numerous wavelengths on the same fiber optic cable.
Faster is better
Optical fiber is currently being deployed across the three major segments of communications networks: long-haul, metropolitan and access. Long-haul networks connect the communications networks of different metropolitan areas around the world and transport large amounts of data and voice traffic. To solve congestion problems, service providers have invested significant resources in the deployment of optical infrastructure, including the use of dense WDM (DWDM).
As a result, current long-haul networks provide very high bandwidth for transmitting data over very long distances. The build-out of long-haul networks represents an important step in improving network infrastructure to support increased demand for new services and greater traffic volumes.
Metropolitan networks connect long-haul networks and access networks. The existing metropolitan network infrastructure has become a bottleneck for the provision of communication services to businesses. Consequently, service providers have begun to invest in infrastructure to help reduce capacity constraints in this portion of the network.
Access networks include business and residential networks. Business access networks connect metropolitan networks and businesses. Traditional business access networks use existing copper-wire-based solutions, which are slow compared to the high-speed networks commonly used within businesses. Both established and new service providers are deploying new technologies to provide high bandwidth connectivity to the business user.
Residential access networks provide connectivity between the metropolitan network and the home. Currently, multiple services such as cable television, satellite, telephony and high-speed data lines are being offered to home users based on multiple copper solutions. As high data rates and new services become widely available to the home user, copper-wire solutions will be increasingly unable to meet consumer demands.
Service providers are beginning to deploy fiber-to-the-home, or FTTH, and fiber-to-the-curb, or FTTC, giving residential users a wide range of current and future services. The widespread introduction of optical networks servicing the metropolitan and access markets will generate significant demand for singlemode fiber optic components.
Single + Single = Power Couple
Singlemode components are coupled to singlemode optical fiber and have superior transmission characteristics in high-capacity longer distance applications as compared to multimode fiber. As data transmission speeds have increased, singlemode fiber has become necessary for even relatively short transmission distances due to its superior performance.
Singlemode fiber has progressed from being the fiber of choice in the long-haul market to being the preferred fiber for most high-speed transmission applications. As speeds and distances continue to increase in the metropolitan and access markets, the need for high performance singlemode fiber optic components will continue to grow.
The increasing use of WDM technology in metropolitan and access markets is also driving demand for singlemode fiber optic components. WDM systems require extensive use of active and passive fiber optic components to enable communication equipment manufacturers to increase system capacity by adding additional light signals on a single optical fiber. The significant growth in the use of WDM systems, combined with the increased use of singlemode fiber in the metropolitan and access markets, is driving the demand for singlemode fiber optic components.
To be competitive in this market, fiber optic component vendors must address a number of challenges, including complex manufacturing and packaging processes and improved delivery times. Component vendors must have high-performance and cost-effective components.
As optical communications networks continue to expand, and systems grow in size and complexity, communications equipment manufacturers will seek to work with fewer vendors offering more complete product lines. Vendors that provide both active and passive components are able to introduce integrated products more rapidly.
Integrated components are typically smaller in size, consume less power and are more reliable and accurate than discrete products that are linked together.
Both active and passive
Luminent, Inc. designs, manufactures and sells a comprehensive line of singlemode fiber optic components that enable communications equipment manufacturers to build advanced systems for the metropolitan and access markets.
Its active and passive products are designed to maximize both distance and bandwidth over singlemode fiber, while providing efficient and reliable transmission. Luminent offers a broad product line of active and passive components in a variety of packaging configurations.
This allows Luminent to satisfy a wide array of customer requirements in metropolitan and access networks.
Luminent also offers a number of products integrating active and passive components, and plans to expand these offerings. As a result of its vertical integration, Luminent can significantly reduce its time to market for innovative product designs.
Leaving the womb
From 1988 until April 2000, Luminent operated as a division of MRV and conducted business using MRV's trade name. In December 1999, Luminent was incorporated in Delaware as a wholly owned subsidiary of MRV.
While operating under MRV, Luminent was an early developer of single fiber WDM optical component technology for FTTC and FTTH applications. These components currently provide next generation high-speed services to hundreds of thousands of homes. Luminent also recently introduced coarse WDM (CWDM) components that enable communication equipment manufacturers to implement WDM inside their equipment at a fraction of the cost of DWDM.
Luminent's active and passive components can be further integrated to provide a more complete solution in the form of WDM subsystems. WDM is used to separate or combine light of different wavelengths or colors, which increases capacity by enabling simultaneous transmission of data along numerous wavelengths on the same fiber optic cable.
Its entire line of passive optical components was established through the acquisition of FOCI and QOI in April and July 2000.
MRV plans to complete its divestiture of Luminent within six to twelve months after this offering by distributing all of the shares of Luminent common stock owned by MRV to the holders of MRV's common stock. Once the shares have been distributed, shareholders can immediately sell into the market, which may cause some dilution. We'll keep an eye on this.
Thin red line
On April 24, 2000, MRV acquired approximately 97% of the outstanding capital stock of FOCI, a Taiwanese manufacturer of passive fiber optic components with facilities in both Taiwan and the People's Republic of China. The outstanding capital stock of FOCI purchased by MRV has been contributed to Luminent. Therefore, the results of operations of FOCI have been included in Luminent's consolidated financial statements from April 25, 2000.
On July 12, 2000, MRV acquired all of the outstanding capital stock of QOI, a Taiwanese manufacturer of active and passive fiber optic components. On July 21, 2000, MRV acquired approximately 99.9% of the outstanding capital stock of OIC, a Taiwanese manufacturer of active fiber optic components.
The acquisitions of OIC and QOI were also contributed to Luminent by MRV as of the date of their acquisition, but will not be accounted for since they came in after the fiscal quarter. OIC and QOI have not been included in any historical financial data presented in Luminent's SEC filing.
Luminent began operating under its own name just this year. And with the recent acquisitions it's hard to predict how well the companies will integrate their operations and act under one name. But these acquisitions do offer Luminent a larger customer base and a more diversified product line. This is a development that bears watching.
Seller's market
No investor likes to hear this, but in this case: sell... sell... sell... product, that is. Luminent currently has an extensive network of direct sales and distributors worldwide. Selling sophisticated and technologically advanced products requires prolonged interaction with customers and a focused effort by the sales and marketing group during the qualification process. The company intends to expand both its direct sales force and its distribution network to provide better service to its existing customers and target new customers effectively.
Its main distributor in North America is Unique Technologies, a subsidiary of Veba Corp. Unique Technologies provides extensive coverage in the United States and Canada for Luminent's two tier customers. Other distributorships have been established in Germany, Japan, the United Kingdom, Taiwan, People's Republic of China, Korea, Benelux, Israel, South Africa, Australia, Spain, France and Denmark.
Its customers include major communications equipment manufacturers, including Cisco Systems, General Instrument, Marconi Communications and Pandacom. In addition, Luminent sells its products through its distributors to Cabletron Systems, Extreme Networks, Foundry Networks and others.
For the year ended December 31, 1999, Luminent's two largest customers, Marconi Communications and Cisco Systems, accounted for over 45% of its net sales, with Marconi accounting for 40% and Cisco for 6%, respectively. For the six months ended June 30, 2000, Marconi accounted for 11% of net sales and Cisco accounted for 13%.
Kneading the dough
Luminent reported net income of US$3.5 million and US$4.2 million for the years ended December 31, 1998 and 1999, respectively. But Luminent reported a net loss of US$10.9 million for the six months ended June 30, 2000. The net loss was primarily due to amortization of goodwill and deferred stock compensation related to the FOCI acquisition. In addition, Luminent will record amortization of goodwill and deferred stock compensation relating to its acquisitions of OIC and QOI and its employment arrangements.
Luminent generally recognizes revenue upon shipment of its products. Net sales for the six months ended June 30, 2000 increased 53% to US$43.6 million from US$28.5 million for the six months ended June 30, 1999. When Luminent consolidates the operations of OIC and QOI, it expects to realize continued growth and expansion in its strategic markets.
Net sales for 1999 increased 69% to US$65.3 million from US$38.6 million in 1998. Net sales for 1998 were 10% higher than the US$35.1 million for 1997. The growth in net sales in 1999 and 1998 was primarily driven by increased shipments of its duplexer and triplexer components to Marconi Communications.
Its net sales increased quarter over quarter in five of the six quarters ended June 30, 2000. Gross profit as a percentage of net sales ranged from 33% to 36% during the six quarters ended June 30, 2000.
Gross profit for the six months ended June 30, 2000 increased 46% to US$14.6 million from US$10.0 million for the six months ended June 30, 1999. Gross profit for 1999 increased 55% to US$22.2 million from US$14.3 million in 1998. Gross profit for 1998 increased 7% over the gross profit of US$13.4 million for 1997.
Its gross margin decreased to 33% for the six months ended June 30, 2000 from 35% for the six months ended June 30, 1999. The decrease in margin was attributed primarily to increased sales to lower-margin customers. While customer diversification improved as a percentage of net sales, absolute dollars shipped to lower-margin customers increased for the six months ended June 30, 2000. Increased labor and component costs also contributed to decreased margins.
Historically, FOCI has realized lower margins than Luminent due to an overall lower-margin market for passive components. In the short term Luminent expects margins to remain constant or decline slightly on integration of the acquired companies with historically lower margins. In the mid to long term, Luminent expects margins to improve via increased operating efficiencies associated with capacity utilization in Taiwan and China, diversification of sales to higher-margin customers, and a favorable shift in product mix toward higher-margin products.
For the year ended December 31, 1999, sales to customers located outside of the United States were 19% of net sales, and for the six months ended June 30, 2000, sales to such customers were 39% of net sales.
Leaders of the pack
The management team has experience but is fairly new. They have not been together long and we'll have to wait and see how the team will harmonize. Keep an eye on any changes in management.
The current chairman of the board took office on July 2000, after having served on the board of directors since Luminent's incorporation. He served as the president, CEO and a director of MRV since May 1990. Before that he served as MRV's CFO.
The president, CEO and a member of the board of directors has served since July 2000. Prior to joining Luminent, he served as group president of the network products group of Lucent Technologies, and as the vice president of the systems and components group, member of the office of the president and co-chair of the executive committee of AT&T Microelectronics. He is also a director of Lyondell Chemical Co., Novellus Systems, Inc. and Raytheon.
The vice president of finance and CFO and secretary has served since July 2000. Prior to joining Luminent, he served as managing director of research and a financial analyst for Pennsylvania Merchant Group, an investment banking firm, where he headed its Technology Group and served as Senior Communications Equipment Analyst.
The chief technical officer has served since June 2000. Prior to that, he served as director of research and development for the optical components division of MRV.
The president of FOCI has served since July 2000. He co-founded FOCI in June 1995 and since then has served FOCI in various senior executive capacities, including vice president of technology, executive vice president of operations and chief operating officer.
Playing with the big boys
The fiber optic business is still fairly new and the market opportunity for Luminent is huge. There were two recent successful fiber optic debuts. Corvis (CORV:NASDAQ) priced 31,625,000 shares at US$36 per share, opened at US$95 and closed for the day at US$84.72. And get this: Corvis originally planned to price only 27.5 million shares at US$13 to US$15 per share, but due to demand, they increased both the price range and the number of shares.
Avici Systems (AVCI:NASDAQ) smoked the market with its debut. Due to demand, Avici increased the size of its offering from 6 million to 7 million shares. Avici priced at US$31.00 a share, up from the original expected price range of US$18.00 to US$20.00. Avici opened its first day at US$93.31 and continues to climb in the aftermarket — trading at US$153.25 as I write.
These returns sound great for those who got in on the IPO. But what about those investors who are thinking about getting in on the aftermarket? There were four fiber optic debuts in the first half of 2000 and they have all remained strong in the aftermarket. With the recent enthusiasm for fiber optics, expect them to continue to do well in the second half of 2000. After that, we'll have to see if these companies can deliver.
Remember, be cautious in aftermarket trading — timing is of the essence, and usually the first few days are the worst for buying a new issue.
Let's take a look at a few of Luminent's other competitors. Agilent Technologies (AGIL:NASDAQ) is trading at US$50.00, Corning Incorporated (GLW:NYSE) at US$240.50 and JDS Uniphase Corporation (JDSU:NASDAQ) at US$110.50. This gives you an idea of the kind of potential Luminent has in this market.
Luminent, Inc. had plans to trade under the ticker symbol LUMN, but this will have to change since it's being used already. The underwriters involved are Credit Suisse First Boston, CIBC World Markets, Robertson Stephens International Ltd., U.S. Bancorp Piper Jaffray and First Security Van Kasper.
If you would like more information on Luminent after its quiet period, contact them at 20550 Nordhoff St., Chatsworth, CA 91311, phone: 818-773-9044, fax: 818-576-9456.
Siu-Yee Ng is the editor of IPO Trader, an IPO alert service that helps readers profit on IPOs and, more importantly, the IPO Aftermarket. Click here to find out how you can put Siu-Yee's expertise and extensive contacts to work for your portfolio.
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