2HRS2GO: Optical leaders helpless before industry slump

COMMENTARY--A successful, well-run business doesn't always make a good investment, and you'll find some of the best examples these days in the optical networking industry.

Corning (NYSE: GLW) and JDS Uniphase (Nasdaq: JDSU) have been toxic stocks this year, losing more than half of their value and trailing the Nasdaq composite index and S&P 500 by Secretariat-style lengths. They have technically impressive products, streamlined costs and market leadership, but the only thing that investors can see these days is a fuzzy future

J.P. Morgan H&Q started the third day of its annual technology conference in San Francisco with Corning and JDS giving back-to-back talks, and the investment bank's clients paid the kind of attention due to the leaders of the most fastest-growing sector of the networking industry by filling the investment show's biggest room. JDS Chief Financial Officer Anthony R. Muller opened his speech this morning on an appropriate note: "We're in difficult times."

That's no secret, obviously. Hollywood stars would kill to get the same amount of press as the slowdown in telecom equipment buying and network construction.

JDS and Corning didn't dwell on their market's problems. All companies at these investment gatherings devote most of their formal presentations to slide show exhibitions of their products. Financial discussions and market forecasts are left to the "breakout" sessions that follow in smaller rooms.

And in those more intimate settings, executives said they still don't know when the market will turn around. Customers' forecasts aren't necessarily reliable, because communications carriers in some cases are assuming they will win the same client that only one of them will actually get, said Gerald J. Fine, executive vice-president of Corning's Photonic Technologies division.

Fine understandably refused to name Corning customers that are overestimating their own business. The important item is his implied point: The optical market right now is hard to predict.

At least Corning can take comfort from the non-optical portion of its business: advanced materials, which includes environmental products such as diesel filters; and information display, focusing largely on glass for flat panel monitors. "All of our other (non-optical) business, some of which frankly looked like liabilities a year ago, look like assets today," Fine said.

JDS Uniphase, on the other hand, has to live and die entirely with optical networking. There wasn't much the company could do to mitigate the sudden downturn, Muller said. If customers are demanding more optical components, JDS has little choice but to comply.

"What are we going to do when a customer is beating us up for (more) product?" he asked rhetorically. "I don't know what we would have done differently without losing market share or sacrificing market share."

In some ways, the economic slowdown and related stock market declines might help. JDS built itself into the top components supplier through acquisitions and should be able to continue along those lines even though JDSU shares have tumbled, Muller said. Publicly traded targets have become few lately, but there are still about 200 privately owned companies in the optical components industry.

"The prices of everything we might buy has also gone down," he said. "The longer this downturn lasts, the cheaper these companies are going to get."

Just about everyone believes the optical market will eventually start growing again. Bandwidth demand continues to rise, and all-optical set-ups handle the load better and cheaper than electronics networks. JDS and Corning are already working on products for OC 768 systems that can transmit data four times faster than OC 192 lines that represent the current high end for networking capacity.

JDS believes communications carriers will consume their current oversupply of optical components by the end of September. But the end of the inventory glut doesn't guarantee an immediate resumption in demand. Neither Muller nor Fine could tell J.P. Morgan H&Q clients when growth in components demand will resume. All they could say is that they'll be ready when things get better.

"We'll have to just go out and spend more money to keep this company going," joked tech hedge fund manager in the JDS audience.

In other words, there's not much Corning and JDS can do right now, and their executives all but admitted it this morning. You can't reasonably fault Corning or JDS for the ineptitude and perhaps sloth of communications service providers. But it's still difficult for a careful investor to own them. 22GO>