Editor's Note: SBC's announcement Tuesday that it would spend as much as $6 billion on its fiber-optic network is the latest confirmation of the regional Bell operating companies' determination to invest in this broadband service.
Cody Willard, our Teleconomist and author of The Telecom Connection, has been a leading voice in the coming FTTP spending boom, and now that SBC has joined Verizon in committing to FTTP, we thought the time was ripe to revisit some of his best work here. Below you'll find four past columns in which Cody outlined his vision for FTTP -- much of which has come to pass, and more of which is still pending. He shared his thoughts on SBC in Wednesday's edition of The Telecom Connection, which published after the close. Click here for a free trial.
FTTP Spells Opportunity
June 4, 2003
I can't remember the last time there was so much real activity going on in the teleconomy. Things are popping all over the place and after that awful three-year dry spell, it's pretty darn exciting to be a part of it all.
The most exciting news of the past couple of weeks was the letter that the regional Bell operating companies, or RBOCs, sent out last week to telecom-equipment vendors alerting them to a pending standards setting for fiber-to-the-premises, or FTTP, networks. Now, readers of The Telecom Connection know that I'm very skeptical of the hype that oozes out of Wall Street, and I've often railed against those hypesters who cluelessly project short-term trends into oblivion, which generates ridiculous revenue numbers from this technology or that.
The funny thing about this news of FTTP deployments is the way that everyone tried to downplay its significance. Most industry analysts told investors and the media that we shouldn't get carried away with what this news meant. Pretty much everybody told me that this was basically a nonevent. I beg to differ. This is simply huge news.
We all know the RBOCs are slow to move, but that slowness served them well during the bubble of the late 1990s and its subsequent deflating. Analysts clamored for years about how the RBOCs would be destroyed by their hesitancy to embrace DSL technology. Instead, the now-defunct competitive local exchange carriers, or CLECs, educated everyone about DSL technology and services, and by the time the RBOCs got serious about rolling out DSL, the technology had been developed fully and the costs had come down enough to make deployment richly profitable. But even though most analysts might have missed it, DSL deployments are now huge and the suppliers of such equipment are still reaping the benefits of the RBOC embrace.
Analysts have been deriding the RBOCs for not rolling out FTTP for years. I've written repeatedly that, in the long run, FTTP is the only way to pipe real broadband into the home. The technology, which uses light waves running through glass, is literally infinitely upgradeable. We're not talking about DSL speeds or 10 times DSL speeds. We're talking about speeds that are literally thousands of times faster than what we now call broadband. Let your imagination run wild.
If the RBOCs roll out FTTP in a sensible, smart manner, they'll eventually be able to not just catch but far surpass the cable companies, who will then need to roll out their own FTTP networks. But I'm getting ahead of myself. It's five to 10 years before all that plays out.
In the more immediate term, I think these long-forgotten and despised optical plays just might suddenly have some catalysts and (dare I say?) potential for growth ahead of them. From all indications, I'm thinking the RBOCs will begin deploying these networks within the next 12 months -- a very short time period by any standards.
I think the RBOCs are going to end up going with a passive optical network, or PON, layout. A PON uses passive components in the network to switch signals and even to mux/demux (combine and separate signals). In layman's terms, it takes disparate signals and combines them into one channel upstream, then takes the one big signal and separates the disparate signal back into separate channels downstream.
The biggest benefit of the PON approach is that those passive components require very little maintenance and carry low operating costs. On the other hand, active switches and componentry run on expensive electricity and have to be regularly maintained. The RBOCs, with their low-cost, low-maintenance history of twisted copper pair technology, are genetically drawn to the PON schematics.
Now it just so happens that I'm intimately familiar with the economics and design of PON networks. I've spent more time designing, planning and modeling PON networks than probably anyone should. So as the RBOCs' plans become more clear, I'll evaluate their models and really dig into the economics and ramifications of the RBOC decision as we go forward.
The Road Map to Fiber-Optic Buildout
July 23, 2003
The rumblings around the pending fiber-to-the-premises buildout continue behind the scenes, and I can hardly contain my bullishness about it. Earnings season had me fielding lots of questions about what to expect from the optical stocks this quarter. But it's important to remember that the opportunity I see here has to do with the FTTP buildout of 2004 and beyond. Although I think the ramp-up of FTTP will come sooner and be bigger than most every other analyst on the Street thinks, that means nothing for this quarter.
Revenue has already stabilized at these very low levels. Sales of Pentium processors might increase or decrease in the coming months, but sales in the optical world can't collapse much further than they already have. Stable revenue and the low enterprise values of these stocks only serve to heighten my bullish thesis. That's not to say these stocks are bulletproof. There will be times when it's nerve-racking to own these stocks, but I'm willing to ride these longs because the upside potential far outweighs the downside risk over the next few quarters.
Here's the route I see this buildout taking. Over the next three to four months, the RBOCs will parse through the requests for proposals, or RFPs, from the equipment vendors and will begin deciding exactly which protocols they will deploy, most likely some sort of 622 Mbps ATM PON schematic. In English, along with my thoughts on the technology, that's 622 megabits per second, which is good for a start (the average DSL speed is about 1/1,000 of that rate); asynchronous transfer mode, which is a shame, because it isn't the most efficient protocol in the world; and passive optical network, which is good for operating costs going forward.
What makes me think the RBOCs are so anxious to get this buildout under way?
(VZ:NYSE) is getting very anxious to get this FTTP project going, and the company expects to begin building FTTP systems in the first half of 2004.
(DISH:Nasdaq) announced an agreement on July 21 to bundle satellite television services with local, long-distance and DSL services. Not surprisingly, the standard response from Wall Street was that this agreement showed that the RBOCs aren't serious about rolling out FTTP. The logic is that SBC wouldn't bother teaming with a satellite company if it was preparing to offer video services on its own. I disagree. I think SBC is getting a jump on the video service provider learning curve, and preparing its customer base for video coming over its own fiber networks. Partnering with EchoStar actually proves how serious SBC is about video, and shows that it wants to enter the fray now.
The market for FTTP is several orders of magnitude larger than any fiber buildout we've ever seen in this country. As a reference point, Japan, which is smaller geographically than California, is currently the largest fiber consumer in the world after rolling out limited FTTP for several years.
The size of the U.S. market and the makeup of its housing, primarily single-family dwellings rather than large apartment buildings, means the FTTP buildout will dwarf any previous demand for fiber service, including the ridiculous overbuilding of the core of the network during the late 1990s. The companies that supply the buildout will see revenue and earnings surge like never before. FTTP isn't just some flash-in-the-pan, unsustainable move, fueled by speculative capital chasing pie-in-the-sky returns. FTTP is the real deal, and it's being fueled by the conservative, rich, profitable and free-cash-flow positive Baby Bells, who will roll it out over several years.
Looking at FTTP from this perspective, you can see why I'm so excited about the prospects for the optical-component suppliers. Avanex and
(JDSU:Nasdaq) continue to look like the most attractive component suppliers, with the right product lines and competitive positioning.
(FNSR:Nasdaq) has a compelling optical-component line that could hit the sweet spot of the FTTP rollout, but it doesn't have the backing of
(ALA:NYSE ADR) and
(GLW:NYSE) as Avanex does; nor does the company have JDS Uniphase's dominant market share.
Corning is another company I'm continually asked about. Its balance sheet carries more risk than I want. Corning is going to be a huge beneficiary of this rollout, and maybe that will more than offset the balance sheet issues, but I just don't like the risk/reward because of how badly the company has been managed during the past five years.
If the rollout begins in the first half of 2004, the equipment vendors will begin to have some visibility into the order flow, and we'll begin to see a pickup in orders of components and building of optical access boxes even sooner than that. So while none of this activity will have much impact on this quarter's numbers or next, there could be some acceleration of business for optical component stocks by the end of this year.
Rocking With FTTP and Wireless
October 1, 2003
Wall Street analysts continue slowly but surely to grasp the ramifications of the fiber-to-the-premises initiative. The most recent evidence came Tuesday, when a Deutsche Bank analyst upgraded
(AFCI:Nasdaq) because the company is likely to win some FTTP business. It's hard to find new ways to explain the potential growth FTTP could bring to the market, but after discussing this upgrade, I'll revisit the history of DSL implementation, which offers a telling road map.
How big is big growth? The aforementioned Deutsche Bank analyst says that, conservatively, more than $4 billion will likely be spent on FTTP equipment by the end of this decade. He didn't break it out explicitly, but as I read it, that estimate doesn't include labor and trenching and operational costs. That's right: Around $4 billion will be spent on FTTP equipment over the next six years. That is a less-than-modest bump up from this year's $30 million.
The amazing thing is that even as analysts like this one start to acknowledge the growth potential within the sector, they fail to grasp the full implications of FTTP. Doesn't $4 billion in sales in a brand new market imply that the suppliers to that market have absolutely mind-blowing growth ahead of them? And shouldn't that explosive growth correlate to a steep rise in these suppliers' stocks over the next few years? It seems obvious, but, remarkably, the sell-side analysts continue to downplay how far these stocks could run. That, of course, is fine by me, as it just means I can slowly build up my positions.
Now for the DSL corollary. The Bells decided in the mid- to late 1990s that they had to get into the residential broadband business and begin rolling out DSL (even though it meant cannibalizing the higher-priced and higher-margin T-1 business). The companies issued a joint RFP for DSL specs and ended up going with an Alcatel platform. But that wasn't the most important step. DSL became huge when the European incumbent carriers and then the Asian incumbent carriers leveraged the U.S. carriers' specs and implemented them. The subsequent spike in demand for DSL equipment drove prices to previously unfathomable levels, and the worldwide markets for DSL ended up dwarfing the U.S. markets in both size and speed of deployment.
These same initial steps are playing out with FTTP. My sources at domestic and foreign carriers are confirming that
(BTY:NYSE ADR) (formerly British Telecom),
(FTE:NYSE ADR) and
(DT:NYSE ADR), among others, are now fishing for information on the specs the RBOCs are working toward. Business cases are being studied and developed, and the boardroom discussions around the globe are not about whether FTTP should be rolled out, but when. Many have already contacted the RBOC RFP finalists like Alcatel and
The Deutsche Bank analyst felt he was being "conservative" in anticipating $4.2 billion in FTTP equipment spending in the U.S. Well, I expect that the global market for FTTP will easily approach two or three times that number by the end of the decade. I ask you: Where else can you find this kind of potential growth?
Telecom Overview: The Top Trend for 2004
December 17, 2003
This past year saw some long-forgotten attributes return to the telecom market: stabilization; access to capital; and a major bounce in the technology and telecom indices. So what does 2004 hold?
No. 1 With a Bullet: FTTP
Drumroll please. The single most important trend for 2004 is ... fiber-to-the-premises. The positive news flow about new FTTP initiatives continues to trickle out, but the universal skepticism remains. Reality be damned, full negativity ahead!
For the thousandth time, FTTP will be the story of telecom by the end of 2004. And it will follow the story arc of voice-over-Internet protocol, or VoIP, which is currently dominating the telecom news flow. That VoIP arc began last year, when I was repeatedly highlighting VoIP as the future of voice telephony while the mainstream press and analysts had little or nothing to say about it. This year, most VoIP stocks have soared, and now everyone wants to know more about VoIP and how it will disrupt the industry. And the stocks continue popping, so investors everywhere are scrambling to find any company that has ever mentioned VoIP in a press release. Say hello to your future, FTTP.
To that end, here's the FTTP news of the week, which the mainstream press is actively ignoring. Tuesday saw SBC, the reluctant FTTP player, announce that it has awarded Alcatel a four-year agreement as its primary FTTP supplier. This is the very same company that had been downplaying rolling out FTTP for months, and suddenly it has announced a four-year deal!
We've now got two of the three big regional Bell operating companies, which combine for nearly 100 million access lines, awarding contracts to move those access lines off of copper and onto fiber. This announcement confirms what I wrote last week, that SBC is actually more serious about moving to FTTP than it's been letting on.
Remarkably (or not so remarkably given the pervasive disregard for FTTP), the press and the sell-siders have made nary a mention of the SBC deal. All the while, there continues to be a steady flow of new contracts awarded by municipalities and smaller rural telecom service providers that are rolling out FTTP on their own. The economics work already, and with the volume growth that the RBOCs will begin driving next year, the economics will only get more compelling.
Now whenever I mention Alcatel, people ask why I don't own the stock. So let me rehash why I don't like this name. The company has positioned itself well during the downturn and is emerging as a leader in most of its product lines, including FTTP. Just as its DSL offerings have been the dominant force for the past decade, I expect Alcatel's FTTP platform will be a tremendous success. But. ...
I just can't get comfortable with Alcatel's balance sheet. There's too much debt and too much exposure to wireless infrastructure. Plus, Alcatel basically paid Avanex to take over its optical component business last spring (just when the optical market seemed to have bottomed, which is yet another reason I don't want to own Alcatel). However, there is a way to play Alcatel's FTTP potential without owning it outright.
Its agreement with Avanex included the provision that Alcatel would source Avanex for no less than 70% of all future optical components. That's why I have so much Avanex in the model portfolio. I find Avanex infinitely more compelling because, with Alcatel as its biggest customer already, Avanex will benefit greatly from any optical growth that Alcatel shows.
And more compelling because Avanex has a pristine balance sheet with no debt to speak of. And because management bought rather than sold at the bottom, and because shares are trading at just about 2 times cash. Get it?
At time of publication, the firm in which Willard is a partner was net long AVNX, JDSU, FNSR, GLW and AFCI, although positions can change at any time and without notice.
Cody Willard is a partner in a buy-side firm and a contributor to TheStreet.com's RealMoney.
He also produces a premium product for TheStreet.com called
The Telecom Connection and is the founder of
Teleconomics.com. The firm in which Willard is a partner may, from time to time, have long or short positions in, or buy or sell the securities, or derivatives thereof, of companies mentioned in his columns. None of the information in this column constitutes, or is intended to constitute, a recommendation by Willard of any particular security or trading strategy or a determination by Willard that any security or trading strategy is suitable for any specific person. Willard appreciates your feedback and invites you to send it to