Expect JDS Buying Spree to Trigger Avalanche of New Optical Listings

SAN FRANCISCO -- All that money and nowhere to go.

Such is the dilemma facing investors in the red hot fiber-optic networking sector. The industry will soon be whittled to three major stocks from seven just a year ago, as voracious acquirer JDS Uniphase(JDSU) has gobbled up one competitor after another, with also-rans SDL(SDLI) and Corning(GLW) following suit. Meanwhile, the parabolic rise of stocks such as JDS Uniphase and SDL has had money flooding into the sector from return-chasing investors everywhere.

Considering the immense demand, the scarcity of stocks tracking the optical phenomenon is sure to ease in the coming year, say analysts. The recent shakeout spells a mammoth opportunity for companies that seek to list optical assets on the public market, and observers say investors can expect to see some big names joining the fray soon.

The Longest Year

A year ago investors in the fiber-optic components that speed voice and data signals along the Internet had no shortage of choices. They could shop among Uniphase, Optical Coating(OCLI), E-Tek Dynamics(ETEK) and SDL, all based in northern California, as well as Nepean, Ontario-based JDS Fitel. They also had Corning, which shed its eponymous housewares division two years ago to focus on optics, and Oak Industries(OAK) in Waltham, Mass.

Each of these companies develops the tiny instruments that ease the Internet's most severe bottlenecks by helping networking equipment companies make products that send extra beams of light through each strand of optical fiber deployed by telecommunications carriers.

But thanks to a flurry of deals, there's now one giant left standing among last year's seven: JDS Uniphase, which, along with its merger partners, had $1.3 billion in revenue from the last four reported quarters -- roughly one-third of the original seven's total optical revenue. The new JDS Uniphase will speak for $105 billion of their $155 billion in market capitalization.

"The investment opportunities in optical components are very limited," says equity analyst Charles Willhoit with J.P. Morgan. He rates JDS Uniphase, E-Tek, Corning and SDL a buy; his firm will underwrite a stock offering by Corning later this month but doesn't have banking relationships with the others. "I still expect to cover five optical networking companies in a year," Willhoit continues. "I just don't know what they'll be called."

The paucity of stocks coincides with a surplus of capital, because the parabolic rise of JDS Uniphase has lured droves of large-fund money managers into a sector they previously regarded as too small.

"As the market cap goes higher, other managers can't afford not to buy it," says Abel Garcia, manager of the (WRTBX)Waddell & Reed Science & Technology and (UNSCX)United Science & Technology funds and a JDS Uniphase shareholder. "The audience goes up as the market cap goes up."

Love at First Sight

Analysts speculate that diversified giants such as Lucent(LU) and Nortel Networks(NT) will feed the shortage by listing separate shares for their optical assets. A host of optical outfits also might go public, provided JDS Uniphase doesn't buy them first.

Jim Jungjohann, who covers optical companies for CIBC World Markets, estimates that Lucent, whose bread-and-butter business is selling phone switches to big telecommunications carriers, is selling $1 billion in opto-electronic products annually.

"We continue to feel Lucent should monetize this hidden optical value," Jungjohann wrote in a recent note. In English: He's advocating that Lucent split the division off as a separate company, create a tracking stock or sell the division, or take a similar route, though he did not return a call seeking further comment. Lucent declined to comment on whether it might spin out its optical division. A Nortel official could not be reached for comment.

A spate of initial public offerings might also serve to sate Wall Street's appetite. During the week of Jan. 31, Fremont, Calif.-based Avanex plans to issue 6 million shares through an offering underwritten by Morgan Stanley Dean Witter. Avanex, backed by Microsoft (MSFT), breaks new ground by packing more signals into each beam of light on a fiber.

Eager for New Names

Thanks to the sweeping consolidation, it quickly has become difficult to diversify one's exposure to a sector that already has soared beyond historically reasonable valuations. Right now investors are too enamored of JDS Uniphase, up about 12-fold in a year, to complain. But they are eager for new names, as attested by the rise of obscure stocks that bear only tenuous links to fiber optics.

The frenzy has drawn investors large and small. Some have even fixated on marginal players such as Precision Optics(POCI), an unprofitable supplier to the medical industry. Thanks to takeout speculation and the announcement of a $1.6 million order from telecommunications customers, Precision Optics has streaked to 26 15/16 at Friday's close, from 1 3/8 in early November. The company is now worth $207 million, or some 74 times its revenue in the trailing four quarters.

That's perhaps the greatest evidence that the market is awaiting more solid operations such as Avanex or Nortel's optical division.

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