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Remember easy money?
Remember back when any optical player that had a new twist or small variation on a switch, router, chip or marketing scheme could get funded, go public and watch its stock soar?
Not today. Not with tech stocks taking a beating, carriers slowing their build-out plans and venture capitalists tightening their hold on money.
The optical market is overcrowded with players. Companies late to the market, those with shoddy business plans and those with untested technology will be the first to succumb. But even those with good ideas are in trouble if they placed their bets on wrong solutions, says Scott Clavenna, a principal analyst at optical research firm Pioneer Consulting.
Be a little late developing 10-gigabit-per-second optical switches, and see your stock fall 85 percent, as Lucent Technologies shares did. Deal with too many customers that cant pay you, such as many of the struggling competitive local exchange carriers, and youre deep in the red. Have a great product but no way to ramp up manufacturing volume, and youre ripe for being acquired.
“Everything cant win, even if it is good,” Clavenna says. “Carriers cant be asked to pick from 20 vendors for a single product. Thats just too many.”
A company might have a good technology and a workable system, but carriers still wont buy it if theyve moved on to something new.
Ciena found that out when it made a run at the metro market. Ciena acquired Omnia Communications and its Asynchronous Transfer Mode-based platform for $429 million in stock in 1999. Omnia had first-rate engineers, but Ciena ultimately abandoned the project because the industry was turning away from ATM.
Ciena was smart enough to do two things: It put Omnias engineers to work on projects that were more marketable, and it jumped right back into the metro market late last year when it acquired Cyras and its K2 platform, pegged to the venerable Synchronous Optical Network (SONET) technology.
“The first thing we learned was that when you find yourself in a hole, stop digging,” Ciena Chief Executive Patrick Nettles says. The Omnia engineering team went on to design Cienas hot Core Director optical switch. “The second thing we learned was that when youre looking at an acquisition, you should focus on the customer contacts and traction that the company has,” he says.
Ciena slipped only once, so it is counted among the winners as 2001 moves into its second quarter. Last month, the company sparked a spike in the stock market when it announced revenue of $352 million for the quarter, up 130 percent from the same quarter a year earlier. Nettles projected that Cienas 2001 revenue would be 95 percent to 105 percent higher than last years.
Nettles believes that optical technology stands at the crossroads this year. “Its a datacentric world, and data behaves in a different way than voice,” he says. With fat pipes and fast switches speeding bandwidth at 10 Gbps, the Time Division Multiplexing solutions of SONET and ATM are increasingly irrelevant, he says.
The newer, faster Internet Protocol (IP) network will cost less to build and will have operational efficiencies. “The sea change will fundamentally differentiate the carriers that use that solution from those that dont,” Nettles says.
The North American optical transport market is expected to double by 2004 to $45 billion per year, according to telecom research firm RHK. By then, 60 percent of vendor equipment revenue will be in IP systems, while the shares for the older frame relay and ATM offerings will shrink, analysts predict.
Lasting Legacy
Lucent and Nortel Networks have long been the leaders in supplying equipment for telecommunications networks. But both had commitments to older technologies for networks built for voice conversations, and both were late with high-speed equipment for datacentric next-generation networks.
Nortels mascot could be Buck, Jack Londons wonder dog of the Canadian north: huge yet fast, smart, nimble and cutthroat when it has to be.
A network equipment company born of the breakup of Canadas staid old national telephone company, Nortel owns an astounding 53 percent of the overcrowded and burgeoning Dense Wavelength Division Multiplexing equipment market. DWDM divides light into dozens of channels — each capable of carrying voice, video and audio traffic — and is expected to be the highest-growth area in the red-hot optical market.
What could go wrong? How about last months forecast by Nortels CEO John Roth that the companys sales would grow just 15 percent this year, an estimate that sent its stock plunging 33 percent?
Nortel is an agile giant by most standards, but in optical networking it seems there is always another company with a newer architecture, a more sensitive finger on the pulse of the market.
Nortel is “perfectly positioned to deliver old solutions,” Nettles says. “They have their whole business built around SONET and ATM. They talk a lot about new systems with new-generation products, but as far as we can see, theyre not delivering much of their touted open-system DWDM systems. They have infrastructure and sales, but theyre missing product.”
But expert observers say Nortel is still plenty nimble. “No incumbent vendors are going to stay on top by continuously leveraging simply what they have,” says Grier Hansen, optical analyst at Current Analysis. “Nortel is a very good example of incumbent vendors that have seen the space explode and know there are a lot of compelling technologies out there from start-ups, and have taken the necessary steps to compete with them.”
Service providers will particularly feel the tightening money supply, Nettles says. “Theres going to be a separation of the haves and have-nots — those that have capital and can move ahead with deployments vs. those who will have to take a conservative wait-and-see approach,” he says. Level 3 Communications, McLeodUSA, Qwest Communications International, Sprint and others that anticipated the tightening and prefunded their build-out plans will enjoy a widening advantage over those without money, he says.
Deploying the hottest new technology will bring advantages to carriers. Last month, Corvis and Williams Communications sent a signal a record-breaking 4,000 miles without regeneration. Williams, one of the new-generation carriers not tarrying in the long-distance voice market, has committed to purchasing $300 million worth of Corvis optical products.
Corvis all-optical products can slash network costs in half because the signals never have to be regenerated, says Shyam Jha, vice president for marketing communications at Corvis. Still, its tough competing with the legacies of Lucent and Nortel, he says. “They have the advantage of incumbency,” Jha says. “Were the new kids on the block, and loyalty counts for something. We have to convince them that this is a better technology.”
Ten years ago, when all routing was done by mainframes, Cisco Systems had a tough time convincing companies that they could save up to 90 percent by buying something called a router, Jha notes.
“What Corvis has going for them that no one else has, is they have a switch that works,” Hansen says. “Their competitors have lambda routers in trials.” Corvis took some heat last quarter for relying on only a few key customers. “But they have one in a network now passing traffic,” he says. “That solidifies the validity of their solution.”
Hansen applauds the newer companies such as Corvis, Sycamore Networks and Tellium on their all- optical products. “Certainly, its harder to get in now in the all-optical market,” he says.
Says Corvis Jha: “Different people see the market evolution differently. The bandwidth barons — Williams, Qwest and Broadwing — are the first to build true optical networks, while the legacy long-distance companies — Sprint, WorldCom and AT&T — are slower. The game is changing rapidly. The newcomers such as Broadwing are selling bandwidth to the granddaddies.”
Lucent is everyones favorite whipping boy, but after overhauling product development and assembly at its optical plant in North Andover, Mass., it is vowing to be the first to market — targeting later this year — with 40-Gbps switches. It also will bring to market this year a lambda router capable of switching up to 1,024 signal channels.
Lucent needed a shock to its complacency, but will come back, says Roger Wery, an analyst at Pittiglio Rabin Todd & McGrath. “They still have some amazing technology and will produce some great products,” he says.
Lucent must trim its complex layers, so the spin-off of its microelectronics division, Agere Systems, and the reported interest in selling its fiber-optics plant are probably good moves. Layoffs, the spin-off, the possible sale and the recent $4.5 billion in bank loans will net Lucent plenty of money to buy cutting-edge technology and vault it into the lead when carriers go on their next spending spree, experts predict.
Nortel, too, will bounce back, Wery says. A good way to start would be to recognize that competitor Cisco has about one-third the employees, with total revenue in the same ballpark. “This may be a trigger to be more nimble and get rid of some of their past and their overhead, to trim down their cost structure and become a sleek athlete,” he says.
Nortel may have slipped a bit, but it hasnt been complacent. Last month, the company announced a suite of products that can make Web surfing easier, and help advertisers target banner ads to individual Internet users. A week later, Nortel purchased a Swiss subsidiary of rival JDS Uniphase, paying $2.3 billion for a company that makes 40 percent of the worlds 980-nanometer pump lasers. Its those pump lasers that are needed for each channel of a DWDM system.
Huge Pipes Are Not Enough
The fastest switches powering the biggest pipes wont necessarily win the game. If size and speed is the only differentiator, everyone will fight to be the discount king, and wavelength will become a commodity in a long price war.
Carriers are looking to vendors that can combine hardware switches with intelligent software so they can offer different classes of Internet services to their customers.
“If you really want to offer carrier-class services over a data network, you need a way to guarantee the performance of the packets,” Light Readings Clavenna says. “The only way is with new forms of switches and routers, and equipment at the edge” of the network.
Celox Networks in January came out with a switch that can serve 6 million subscribers at a time and deliver 16 levels of service, from firewall protection to voice-over-IP to bandwidth on demand. It allows service providers to offer the basic $29.95-per-month service, but then easily ramp up to about $60 per customer with the lure of the gold-plated options.
The services-creation field is crowded with new products from CoSine Communications, Lucents Spring Tide Networks, Nortels Shasta line, Quarry Technologies and Redback Networks, among others. Theyre all stuck in second gear, waiting for a killer application to come along so carriers can fill their bandwidth and start clamoring for faster switches that can deliver even more traffic.
Equipment vendors would do well to remind themselves how pragmatic and bottom-line oriented their carrier customers are — especially now that financing is tight.
Global NAPs, an eastern seaboard carrier, is buying voice packet switches from Convergent Networks because it needs to make money now, and can do so with equipment geared to ATM protocols. Frank Gangi, president of Global NAPs, is convinced that ATM has a lot more life left in it — and some advantages over IP. “IP doesnt have quality of service inherent in its protocol, but ATM was written from the outset with QOS in mind,” Gangi says.
The fact that IP works best with the cheap-to-install, popular and newly speedy Ethernet technology doesnt daunt Gangi. “For every argument I can make about how great ATM is, they can make an equally passionate argument about IP,” he says. “But quality of service is just not there with IP. We couldnt migrate to any solution, no matter how cheap or fast or sexy, if your phone call is going to sound any different than it sounds on the traditional circuit network. If youve ever used IP telephony, it drops and garbles too much.”
With equipment from Convergent, Marconi and Sycamore, Global NAPs network “isnt a spider-web mass of 50 lines in 50 places,” Gangi says. “Its one big, fat pipe into an ATM cloud. Its much more efficient and you get real savings. Plus, its about a tenth the cost of traditional stuff. And it offers new services that Class 4 switches didnt dream of.”
ONI Systems Hugh Martin doesnt agree about ATMs future, but thats what makes horse races. Hes betting on IP “for one simple reason: Never bet against Ethernet,” he says.
Ethernet, a protocol most commonly used with IP, is cheap and simple to install. The rap has been that its slow. But with optical fiber, Ethernet has moved up from 10-megabit-per-second speeds to 100-Mbps to gigabit-per-second speeds. “And were less than nine months away from 10-gig [Gbps] Ethernet,” Martin says. “Its just relentless. Its a technology that never loses. And Ethernet is IP. Over time, ATM is going to go away.”
The dozen companies making intelligent devices for what they believe will be an IP future are trying to put a lie to the claim that IP and Ethernet dont allow service providers to offer different classes of service.
Playing Well With Others
As optical fiber moves closer to the customer, the challenges and the competition escalate. Equipment vendors that can form partnerships with component or fiber makers are at an advantage.
Quantum Bridge Communications makes optical equipment for the edge, where businesses are connected to the network core. Last month, it announced a partnership with Corning whereby they become each others preferred vendors. “We help our customers get access to Corning fiber, and Corning helps its customers who want optical to reach their business to get access to our equipment,” says Jeff Gwynne, vice president of marketing at Quantum Bridge. “We look at partnerships to provide fuller solutions.”
Quantum Bridge also allies with companies such as Marconi and Nortel so it can focus on innovation and let others worry about providing interfaces with different technologies and protocols, Gwynne says.
Analysts point to another reason why they think the optical market will soar — or at least outperform the entire high-tech sector. Salomon Smith Barney expects the shared-storage business to grow to $40 billion per year by 2003. Thats increasingly a metro-area business, because the storage centers need to be close to large businesses. And with the bandwidth those centers demand, the only conduit that can deliver it is, of course, optic fiber.
The optical space isnt as hot as it once was, but there will be continued exploding demand for bandwidth, “and thats not going away,” says John Kane, CEO of Telseon, which lights fiber in the metro area and sells it to service providers. “The cheapest and easiest way to deliver that is over optical networks.”
Telseon last month won $175 million in financing from investors sold on its business plan. Investors were just as sold on Yipes Communications, which plays in the same space, but sells services directly to businesses. Investors gave Yipes $200 million last month. Both companies completed fiber-optic rings around 20 U.S. cities by the end of last year.
“Money is sitting on the sidelines until they understand where the bottom of the market is,” Kane says. “Money will then start to flow back into the market, albeit cautiously.”
To survive as an equipment vendor today, “dont get involved in religious wars,” Gwynne suggests.
He urges vendors to provide solutions for big incumbent carriers, new competitors, cable television and those that run various protocols and technologies. “You cant say, Im going to be an IP bigot, or an ATM bigot,” he says. “You have to provide equipment that guarantees their investment in any of that. Listen to your quality customers. Most of what they want is going to be widely commercially applicable. Give them total solutions and love and care. Thats whats going to separate winners from losers.”
And one more thing: “Run like hell,” he says. “Speed is life. We have a saying around here: The guys that are quicker and most agile will win the race.”