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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 that 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.

Take a Right Turn in Albuquerque

Here's the route I see this buildout taking. Over the next three to four months, the regional Bell operating companies will parse through the requests for proposals (RFPs) from the equipment vendors and will begin deciding on exactly what 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's not 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?

Verizon

(VZ) - Get Report

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.

SBC

(SBC)

and

EchoStar

(DISH) - Get Report

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 foray now.

How Far? How Fast?

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.

Look at it this way: If

Avanex

(AVNX)

expands its revenue as I expect it will next year, we'll see 25% sequential growth per quarter for several years. Coming off a $25 million dollar per quarter revenue base, and estimating 15% net margins (which while aggressive, isn't ridiculous for a component business in a growth phase), Avanex would earn 14 cents per share in the eighth quarter of that growth phase. That would mean annualized earnings of 56 cents a share in the middle of 2005.

But there's more. Those earnings would jump to 35 cents a share in the 12th quarter, or $1.40 per share annualized, in the middle of 2006. Ex-ing out the $2 per share in cash on the balance sheet, that means buying shares now gets investors a strong company with a unique product line that is about to explode in growth for 2.5 times 2005 earnings and one times 2006 earnings.

Looking at FTTP from this perspective, you can see why I'm so excited about the prospects for the optical-component suppliers. Avanex and

JDS Uniphase

(JDSU)

continue to look like the most attractive component suppliers, with the right product lines and competitive positioning.

Finisar

(FNSR) - Get Report

has a compelling optical-component line that could hit the sweet spot of the FTTP rollout, but it doesn't have the backing of

Alcatel

(ALA)

and

Corning

(GLW) - Get Report

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. >

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. At time of publication, the firm in which Willard is a partner was long Verizon calls, Avanex, Finisar and JDS Uniphase, although positions can change at any time and without notice. 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 cwillard@realmoney.com.