up & down the food chain—icc2002.ieee-icc.org/notes/ieee2002_hasanimam_bas.pdf · the...

Up & Down the Food Chain—

Perspectives on the Communications Equipment Landscape

Hasan Imam, Ph.D. Partner

Senior Equity Research AnalystWireless & Wireline Equipment

(212) 271-3698 [email protected]

Associates:

Bobby Sarkar, 212-271-3582

Mike DeMichele, 212-271-3798

The “100-Year Flood”

The world has changed…− Since early 2000, NASDAQ has lost 65% of market capitalization− Enron’s share price collapsed from $36 to $0.60, wiping out $26 billion in market cap in 35 days− The top 20 telecom equipment vendors have lost $1.5 trillion in market capitalization

$-200b

-$100b

Mar

ket

Cap

Lo

st S

ince

Pea

k

$-300b

Enr

on (-

$53b

)

Cis

co (-

$420

b)

Nor

tel (

-$23

3b)

Luce

nt (-

$235

b)

$-400b

Source: Thomas Weisel Partners LLC

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“How Did We Get Here?”

A Brief Post-Mortem

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The Communications Food Chain

Enterprise Residential

Services

$2 trillion

Components & Modules

Systems

Networks

WirelessAT&TSprintWorldcomNextel

TelephonyAT&TSBCBellSouth

Internet ContentYahoo!AmazonE-tradeTravelocity

Web HostingAkamaiPSI NetDigex

Internet Service ProviderAOL@Home BeneluxUUNetConnect2

CableCNNHBOMTVESPN

Cable NetworksAT&T/TCI/MediaOne

Time WarnerComcast

Undersea Global CrossingTycomOxygenAfrica One

IXCs RBOCs CLECsAT&T BellSouth Delta 3Sprint SBC NEONWorldcom Verizon Telew est

Telecommunications Networks Next-gen NetworksEnronLevel 3Qw estWilliams

UnderseaAlcatelKDDTyco

IntegratedAlcatelCiscoEricssonFujitsuLucentMarconiNortelTellabs

OpticalCienaCorvisONI SystemsSycamoreTellium

DataAviciExtremeJuniperRedback

WirelessNokiaEricssonMotorola

Cable & AccessADC TelecomScientif ic AtlantaHarmonicAntec

Comm ICsTransSw itch

PMC SierraVitesse

AMCC

Optical ComponentsAvanexBookhamCorningJDS UniphaseNew Focus

WirelessSprint PCSAT&T WirelessVerizon WirelessVoiceStream

The economics of a food chain… the boom and the bust begins at the top


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Strong Tailwinds Up The Food Chain

Convergence of Major Trends Creates the Perfect “High”

Deregulation

Telecom Act of 1996 opens up the floodgates

Number of carriers mushroom from 10s to 100s

Birth of the Internet

Creates vision of an “e-centric” world…

…fueled by unprecedented growth in data traffic

Influx of cheap capital

Venture Capital

Public equity / debt

Cross-over funds

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Creates The Spending “Upcycle”

AT&TMCI/Sprint

QwestLevel 3

Williams

SBCUSWest

Bell SouthBell Atlantic

Pacific Telesis

AT&T

Monopoly

Regional

Long DistanceLong Distance

Incumbent Regional

Competitive Regional(over 1000)

AT&T

SBCUSWest

Bell SouthBell Atlantic

Covad CommDSL.net

GST TelecomNEXTLINK Comm

North Point

1987 1996 Present

Deregulation

Data traffic growth

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1998 1999 2000 2001 2002E 2003E 2004E

Aver

age

Cal

enda

r Day

Tra

ffic

$136,292

$242,855

$183,130

1998 1999 2000

Cap

ital S

pend

ing 34%

33%

Wireline capex growth ($mn)

Source: Company reports and Thomas Weisel Partners LLC

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Economics Lesson 101: “Too Many Cooks Spoil the Broth”

As # of carriers mushroom

All bite the same pie

Intense competition kills pricing

As buildout frenzy continues

Capex/revenue grows to unsustainable levels

Debt loads mushroom

Makings of a “bear” run

Revenue growth stalls

Margins collapse

FCF in negative territory

Capacity utilization shrinks

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The “Capex Downward Spiral”

Carriers have 2 sources of funding: (1) Capital Markets – External; (2) Cash Flow - Internal

…When investor “honeymoon” is over, access to external capital can dry up

IMPLICATION: When stock collapses, focus shifts to cash preservation & profitability, management dials down the only discretionary component of spending – capex!

External Funding

Equity Markets

Debt Markets

Net cash low due to debt servicing

Asset value fallsDeclining securities creates capital squeeze

CAPEX

Internal Funding

Cash Flow

Asset Sales

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Capex Takes A hit

As both sources of capex funding dry up…Internal: operating cash flow

External: public/private financing

…Capex collapses

Wireline Capex ($mn) Wireless Capex ($mn)

$156,948

$220,285$238,602

2000 2001 2002E Credit Weighted

Cap

ital S

pen

din

g

-8%

-29%

$66,463

$70,651

$60,777

2000 2001 2002E Credit Weighted

Cap

ital S

pen

din

g

6%

-14%


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Public Markets React First

As spending stalls, havoc down the food chain

CHAIN REACTION:1. Stock prices collapse

TEXT EXAMPLES OF STOCK DECLINES OR EQUIPMENT INDEX

Source: FactSet

Index Includes: CIEN, CORV, CSCO, ERICY, JNPR, LU, NOK, NT, ONIS, RBAK, SCMR, SONS, TELM

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Public Markets React First (cont’d)

2001 - Total Issuance: $219 bn

22%

14%

7%

16%

41%

2000 - Total Issuance: $248 bn

13%

12%

14%

15%

46%

10%

11%

6%

14%

59%

2002 YTD - Total Issuance: $49 bn

Technology

Healthcare

Other

Energy

Media / Telecom

2. IPO markets shut down

Market-wide New Issuance Volume

$101.7

$32.9

$6.9

$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

($ b

n)

2002 YTD20012000

Technology Issuance

-68%

Source: Venture Source and Thomas Weisel Partners LLC Investment Banking

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Public Markets React First (cont’d)

Source: Securities Data Corporation. Announced deals for each annual period (disclosed transaction value), includes all Technology, except Biotechnology. Data as of March 14, 2002.

# of Deals$ Volume

$14 $33$70 $75

$152 $167

$506

$716

$526

$320

$12$23 $13$0

$100

$200

$300

$400

$500

$600

$700

$800

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 YTD 2002

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

3. With weakened stock currency, M&A market activity cools down

Overall Technology M&A

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…And Private Markets Follow

Reg

istr

atio

ns w

ithd

raw

n ou

tnum

ber

regi

ster

ed b

y ro

ughl

y 12

to

1

File Latest Filing Range Shares Amount Latest Filed Date of most Date of Company Date Low High Filed Filed 1 VValuation Recent S-1/A Withdrawal

In Registration:Centurion Wireless 9/22/00 N.A. N.A. N.A. N.A. N.A. N.A. N.A.Unisphere Networks 8/24/01 $11.00 $13.00 8.50 $102.0 $1,285.9 8/24/01 N.A.

Withdrawn:Optical Access 10/6/00 $11.00 $13.00 5.00 $60.0 $560.0 12/18/00 11/15/01Qualcomm Spinco 7/25/00 9.00 11.00 N.A. N.A. N.A. 7/25/00 N.A.StorageApps 11/3/00 N.A. N.A. N.A. N.A. N.A. 11/27/00 7/25/01Snap Appliances 10/30/00 N.A. N.A. N.A. N.A. N.A. 11/13/00 6/13/01IPG Photonics 12/8/00 14.00 16.00 8.20 123.0 1,506.7 3/6/01 6/7/01Quantum Bridge 12/19/00 N.A. N.A. N.A. N.A. N.A. N.A. 5/25/01Zhone Technologies 10/19/00 N.A. N.A. N.A. N.A. N.A. N.A. 5/8/01CiDRA 10/11/00 14.00 16.00 6.70 100.5 861.7 12/21/00 4/16/01Sitara 11/17/00 N.A. N.A. N.A. N.A. N.A. N.A. 4/16/01SiRF Technology 10/6/00 10.00 12.00 5.00 55.0 349.3 11/13/00 4/12/01Convergent Networks 9/28/00 15.00 17.00 5.00 80.0 967.2 12/18/00 3/30/01Conexant Spinco 11/13/00 N.A. N.A. N.A. N.A. N.A. N.A. 3/26/01ILX Lightwave 9/1/00 15.00 17.00 5.00 80.0 578.2 11/3/00 3/26/01Intellon 8/31/00 11.00 13.00 6.25 75.0 411.9 11/17/00 3/21/01Chorum Technologies 10/31/00 16.00 18.00 8.00 136.0 1,170.4 2/2/01 3/15/01Wavesplitter 10/4/00 9.00 11.00 10.00 100.0 794.3 1/31/01 3/12/01OMM 12/15/00 10.00 12.00 9.00 99.0 1,138.5 12/15/00 3/9/01Chaparral Network Storage 3/8/00 N.A. N.A. N.A. N.A. N.A. 4/27/00 2/16/01Telect 8/30/00 9.00 11.00 12.00 120.0 1,311.7 11/14/00 2/7/01NETGEAR 9/8/00 N.A. N.A. N.A. N.A. N.A. 10/3/00 2/7/01XACCT Technologies 3/28/00 9.00 11.00 5.00 50.0 N.A. 11/9/00 1/29/01Anda Networks 8/15/00 N.A. N.A. N.A. N.A. N.A. N.A. 12/26/00Open Port Technology 4/5/00 N.A. N.A. N.A. N.A. N.A. N.A. 12/18/00Xpeed 7/21/00 N.A. N.A. N.A. N.A. N.A. N.A. 11/22/00MCE Companies 7/27/00 13.00 15.00 8.8 122.9 418.3 10/13/00 10/18/00

No exit in sight

Source: Venture Source and Thomas Weisel Partners LLC Investment Banking

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Privates – Last Shoe To Fall

First Quarter Second Quarter Third Quarter

Average Change in Valuation from Prior Round for Recent Late Stage Financings

Non-Insider Led Round Insider Led Round*

* Treats affiliated funds associated with insiders as an insider.

38%

62%

33%

67%

Fourth Quarter

(68%)

104%

(49%) (64%)

(100%)

(75%)

(50%)

(25%)

0%

25%

50%

75%

100%

125%

Q1 Q2 Q3 Q4

50%50%

0%

100%

Leading to valuation collapse…

Insiders leading larger portion of private fundings as investors shy away from new transactions

Valuations coming down

Source: Thomas Weisel Partners LLC Investment Banking

Source: Thomas Weisel Partners LLC Investment Banking

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After the “100-Year Flood”

Path to Recovery

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Phases of Recovery

1. Weaker service providers will die out− Bankruptcy/Reorganization —Teligent, Winstar, Rhythms, Global Crossing, XO, Williams, McCleod− Consolidation—AT&T/Northpoint

2. Survivors are few− Incumbents – reemergence of the “super carriers”− Next-gen, facilities based players with strong business plans and management teams may survive

3. Demand consolidates to survivors

− Absolute unit demand picking up =- revenue boost

− Carriers regain pricing leverage = margins expand

4. Surviving service providers begin reporting healthy quarters

5. Capital markets open up to survivors− Debt markets

− Equity financing

6. Capex budgets recover

While exact timing of events not easy to predict, we chart the course…

Similar dynamics down the food chain

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The Future

Super-carriers with 80% of the spending power

Consolidation down the food chain in equipment space Big vendors with good customer relationships/distribution channels will dominate; not necessarily technology leaders

Mid-sized niche players with technology leadership will thrive

Private companies more likely to be sell-side M&A candidates than IPOs

AT&TNortel

1987 1997 Current

AT&TSiemensEricssonAlcatel

Japan, Inc

NortelLucentCiscoAlcatel

SiemensNEC

Fujitsu

TycomAlcatelKDD

CienaCorvisJuniper

ONIRedbackSonus

SycamoreTellium

North America

Internationa

l

Large Cap Dvsd

Undersea

Pureplay

(>3000)

Future

NortelLucentCiscoAlcatel

SiemensNEC

FujitsuLarge Cap Dvsd

CienaCorvisJuniper

ONIRedbackSonus

SycamoreTelliumPureplay

(<100))


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Assessing Health: 2002 – A Period of Transition

2002 will continue to be challengingYear-over-year capex to be down 30% globally

…but quarterly capex rates should stabilize by 2H02

“Anchor Stocks” (Large-cap diversified vendors) need to stabilize firstCisco posted 8% growth in January’02 quarter, flat in April?

Nortel revenues still decelerating, stabilize by June’02?

Lucent revenues flat in March, stabilize by June?

Pure-plays will trade on a multiple of “anchor stocks”

Selected U.S. Capex

$14.3

$10.1$11.0

$12.0$12.9

$5.0

$7.0

$9.0

$11.0

$13.0

$15.0

4Q01 1Q02E 2Q02E 3Q02E 4Q02E

Qua

rterly

Cap

ex

-29%

9%

8%

8%


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Longer-Term The Picture Looks Bright

This is not a “dot-com” phenomenonCommunications services generate $2 trillion in revenues globally

Networks are the most strategic assets carriers have

In the worst telecom recession in 15 years, carriers still spending $220bn annually

Traffic continues to grow at a robust paceCarriers are “distributors” of content

Key long-term indicator of industry health is end-demand from enterprises and consumers

Best positioned carriers still reporting year-over-year data revenue growth > 30%

Once current absorption cycle works through, demand will returnCarriers must maintain networks – consolidation will increase size of Tier-1 networks

We will not return to “pre-1996” era in terms of competition

Carriers must invest in growth – we expect capex to grow at historical normalized levels of 10-15%

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Lessons Learned – Success Will Come From…

Focus on profitability rather than blind top line growthDays of “quick buck with an IPO” are over – its no longer a sprint but a marathon

Focus on building a business with a sustainable model is key

Focus on customer – of the “right” kindIf customer “has the flu” it will will spread down the food chain – just a question of time

Capex is consolidating among Tier-1 carriers – choose your customer carefully

Focus on business model – its not just about technologyPay attention to customer business model – how do you add value?

When customer has $2 to spend, may spend $1 on “experimental” technology – when there is only $1 to spend will spend on necessity and highest ROI technology

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Additional Slides Specific to Metro

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Metro Has Fared Better Than Long-Haul

Metro revenues fall but not as much as long-haul…Ciena’s metro revenues are still projected to be up 15% from CY1Q01 vs. long-haul fall of nearly 40%

Nortel’s metro and enterprise segment was down 11% in 4Q01 from 1Q vs. 40% for its long-haul segment

ONI’s revenues, while down 41% sequentially in 3Q01, are still projected to be up over 200% YoY for 2001

Metro revenues Long-haul revenues

Nortel metro revenues

$1,779$2,361

$2,795$1,926

$0$500

$1,000$1,500

$2,000$2,500

$3,000

1Q01 2Q01 3Q01 4Q01

CAGR = -11%

Nortel Long-haul revenues

$259

$1,202

$390 $425$0

$200$400$600$800

$1,000$1,200

1Q01 2Q01 3Q01 4Q01

CAGR = -40%

Ciena Long-haul revenues

$94

$349 $343$232

$0

$200

$400

1Q01 2Q01 3Q01 4Q01

CAGR = -35%

Ciena metro revenues

$42$57

$28 $42

$0

$20

$40

$60

1Q01 2Q01 3Q01 4Q01

CAGR = 15%


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But Wall Street Has Not Been Kind to Metro Vendors

Stocks have fallen 80% over the last year

Source: FactSet

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Longer-Term The Picture Looks Bright

This is not a “dot-com” phenomenonCommunications services generate $2 trillion in revenues globally

Networks are the most strategic assets carriers have

In order to maintain and grow networks, carriers still spending $200bn annually on telecom equipment

Traffic continues to grow at 100% by most conservative estimatesCarriers are “distributors” of content

Key to long-term indicator of industry health is end-demand – remains robust

Once current absorption cycle works through, demand will returnMetro likely to be one of the key beneficiaries, with RBOCs stepping in

Equity markets will stabilize by 2H02, growth thereafter at a healthy pacePsychology is more bullish than fundamentals, already reflecting future growth

NASDAQ already up 41% since post 9/11 lows

Once sector is stabilized by “anchor names”, pure-plays will trade at premium/discount given growth prospects

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up & down the food chain—icc2002.ieee-icc.org/notes/ieee2002_hasanimam_bas.pdf · the...

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