Let there be light
EDN Staff - June 1, 2000
The boom in optical telecommunications has a dark side. While component companies are riding run-away demand all the way to the bank, their major customers are suffering delays in shipments and drops in their stock prices because of a significant component shortage.
Several years ago, when major telecom companies began to rebuild and expand their networks using fiber optics, the supply of fiber optic components was mostly captive. Companies such as Nortel Networks Corp., Brampton, Ontario, made their own parts for their systems. But over the last two years these companies' demand has exceeded their internal supplies, and they've begun sourcing from an infant merchant market ill-prepared to meet the surging demand.
The most prominent merchant component suppliers include JDS Uniphase Inc., San Jose, CA, (which, with its recent acquisition of E-Tek Dynamics Inc. becomes the dominant supplier) and SDL Inc., also of San Jose. Two years ago, these companies' products went primarily into government, satellite, medical and other niche applications, according to Charlie Willhoit, senior equity analyst at J.P. Morgan & Co. in San Francisco. Now these applications have been overwhelmed by telecom. For example, three years ago, less than 25% of SDL's sales were in telecom, he notes. In its latest quarter, that number was 83%.
These companies have grown fast over the last two years, and their stock prices have soared. JDS Uniphase posted strong third-quarter results in late April, reporting a sales increase of 150%, and predicted revenue growth of 75% in FY 2001. As of May 5, its stock was up 488% from May 5, 1999. Similarly, in its most recent quarter, SDL beat analyst's earnings estimates and said it will have to expand manufacturing capacity sooner than expected. As of May 5, its stock price was up 536% from May 5, 1999. But on the systems side, companies are suffering. When Lucent Technologies Inc. announced poor quarterly results in January and blamed them at least partly on the component shortage, its stock dropped to a 52-week low. The Murray Hill, NJ, company lost $54 billion in market cap in one day, according to Stephen Montgomery, president of ElectroniCast Corp., a market research company in San Mateo, CA. "Ever since that $54-billion drop, people have been kind of tight-lipped about the component shortage problem," he adds. Nevertheless, there have been similar references to the shortage from others, like Lisle, IL-based Tellabs Inc. Its stock hit a 52-week low in mid-April.
Montgomery claims that typical lead times for some fiber optic components have stretched from six to eight weeks to 24 weeks to a year.
"[Contractors] are putting the fiber cable in and it's just sitting there dark until the systems and components can be delivered," he says. He thinks current demand is at least 20% higher than supply.
The shortage is most in severe dense wavelength division multiplexing (DWDM) components, says Arlon Martin, general manager of the optoelectronic components division of Lucent's Microelectronics Group, Allentown, PA. The company had forecast a quadrupling of demand for these components over the last year. Instead, demand increased tenfold, especially among the 10-gigabit-per-second DWDM parts, he explains. As for other types of components, including lasers, fiber amplifiers and receivers, "I don't know if I'd characterize it as a shortage," he says, "but we could sell more than we are making."
The shortage is not likely to end soon-duration estimates run anywhere from one to more than three years. That's because building these components is complicated and labor-intensive, Willhoit notes. "Certain optical components-such as high-powered pump lasers and very advanced filters carry yields in the single digits," he says. Much of the work is done by hand. "It's like the electronics world of 50 years ago," he explains, adding that some 80% of JDS Uniphase's employees are assembly-line workers.
Although a slew of start-ups are entering the market to try to fill the void, "the barriers to entry are enormous," says Willhoit. Not only are the parts complex and hard to build, but it's also difficult for new suppliers to add huge amounts of capacity, get their components tested and qualified to stringent telecom reliability standards, and get designed into major customers' applications, adds Lucent's Martin.
The new companies, of course, beg to differ. "This is a very fertile environment to create start-ups," says Bob Shine, director of marketing at WaveSplitter Technologies Inc., Fremont, CA. He claims that telecom companies will test a component and design it into their systems more rapidly than before, simply because they are in such dire need. WaveSplitter claims it has a DWDM component that is easier to manufacture at a cost lower than its competitors' devices.
Telecom companies would prefer to source more components from the merchant market, but the urgent immediate demand is forcing them to increase their investments in internal manufacturing says Willhoit. Lucent, for one, has taken several steps. In February, it announced it would spend $30 million to expand its optoelectronics component operations, including building a new facility in Breinigsville, PA, and renovating its existing factory in Reading, PA. Noting that the company's optoelectronics business grew 83% last year (including internal sales), Lucent expects the expansion to quadruple its components output by the end of this year. (Most of Lucent's opto components-typically 75%-are sold to outside customers, according to Martin.) The company also plans to spend $1 billion on optoelectronics R&D over the next three years. And in late April, Lucent's Microelectronics Group completed the acquisition of Ortel Corp., Alhambra, CA, a maker of optoelectronic components for the cable TV market.
Lucent is using automation in its existing and new factories to help increase the yields on these complicated parts, Martin points out. "We have the most automated laser manufacturing facility in the industry," he says.
Automation will help, but isn't likely to alleviate the shortage anytime soon. One analyst compares what's happening to the boom of the memory chip market. Remember when the industry's first PCs had only 4 kilobytes of memory? But the more memory that was put in the PC, the more it was consumed by applications.
"Today, we're in a bandwidth-begets-bandwidth market," says Jay Liebowitz, director of optical components at San Francisco-based RHK Inc.-Tam Harbert