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Investment Themes in Optical Networking
September 2001
Bill Magill – Optical Components & Systems
Overview
 Optical networking: defining the ecosystem
 State of the industry
 Looking forward: the bad and the good
 Identifying the pain
 Relieving the pain
 Hot growth opportunities
 Creating a Metric Of Interest
 Investment summary
2
Defining The Ecosystem
3
Food Chain In The Optical Networking Industry
Systems: access, metro, long haul
Modules & Subsystems: amplifiers,
switches, ADMs, transponders
Discrete components:
passives, actives, planar
Materials & Methods: Wafers,
Fiber Preforms, Processes
Kigre Glass
4
Optical Networking Means Transparent Optical Solutions
STS-1 grooming:
Ciena CoreDirector
 O-ADM ring/mesh
management:
Sycamore SN16000
Opthos IW 1000
Corvis CorWave OCS
Movaz RAYstar
 switching:
Calient DiamondWave
Lucent LambdaRouter
Corvis CorWave ON
Matisse D2WDM
 access:
AllOptic GigaForce
 mux & termination:
Paceon BPon
Ciena MultiWave
Quantum Bridge QB
PhotonEx PX Ultra
Nortel OPTera
LH Core
Metro
Access
Metro
Core
OSP (amp, disp comp, DGE):
MSPP, aggregation:
NP Photonics
Cisco ONS 15454
Yafo
Astral Point ON 7000
Ciena MetroDirector K2
5
ZettaLight
The Optics Ecosystem – Systems & Subsystems
PON
OSP
WDM
Terminals
OXC
WDM Terminals
O-ADM, OXC
Calient Lucent
Optical Add-Drops
Opthos
True Optical Switches
Matisse
Calient Movaz
AcceLight
Lucent GlimmerGlass
Naynav Corvis Alcatel
Optical Access
Cinta Nortel Tellium
AllOptic Eluminent
Marconi Paceon
Optical Solutions OKI
Quantum Bridge
Siara TeraWave
OSPs
Optical Switch Plans?
NP Photonics Optellios
Ciena
Teem Photonics Phaethon
Sycamore Tellabs
Zettalight Yafo
Xtera JDS Uniphase
Southampton Ph Corning
6
Nortel Cisco
Alcatel Hitachi
Fujitsu NEC
Siemens Sycamore
Tellabs Reversi
Ultra Long-Haul
Corvis Innovance
Solinet Nortel
PhotonEx
The Optics Ecosystem – Component Technologies
WDM
Terminals
OXC
O-ADM, OXC
Tunable Filters
FBG
MEMs
Etalon
Liquid Crystal
Attenuators
solid state
MEMS
Thermo-optic
Electro-optic
Pump Lasers
edge emitters
surface emitters
diode-pumped SS
Yb fiber lasers
Filters
Thin film
FBG
AWG
Bulk gratings
AO  Conv Switches
Modulators Lasers
SOA – MZ
MEMS
LiNbO3
DFB
SOA - Gated Polymer
IP
FP
LiNbO3
Bubble
Polymer
VCSEL
SOA
Ext Cavity
Liquid Crystal
Tunable
Thermo-optics
Detectors
Electro-optic
Holographic
Other passives
Isolators
Circulators
Collimators
Connectors
Interleavers
7
Select Companies Developing Active Components and
Subsystems
8
Broadview, 9/01
Select Companies Developing Passive Components and
Subsystems
9
Broadview, 9/01
Select Companies Developing Integrated Planar Optics
10
Broadview, 9/01
State Of The Industry
11
Internet Traffic Growth Has Slowed
200%
Annual Growth
180%
160%
140%
120%
Recovery
100%
Soft Landing
80%
Contraction
60%
1999
2000
2001
2002
2003
2004
RHK, 5/01
12
Carriers Over-invested Into The Slowing Growth
Carrier Spending Ratios
6.0
5.0
Averaged Carrier Revenues Divided By Average Capex
4.0
3.0
2.0
1.0
0.0
1996
1997
1998
13
1999
2000
2001
System Suppliers Have Seen Demand Dry Up …
Ciena
Alcatel
Lucent
Nortel
ONI
Revenue Growth Comparison ($M)
TTM
CY01E
% Change
% Ch. 00/99
1,520
1,611
6
98
27,101
23,760
-12
36
24,800
23,200
-6
na
26,500
22,400
-15
31
160
250
56
1,866
14
… And The Market Outlook Revised Down, …
$53
Nov '00
Recovery
$48
$43
Billions
$38
Soft Landing
$33
$28
Contraction
$23
$18
2000
2001
2002
2003
2004
RHK cuts NA Optical Transport Market Outlook by ~25% in May.
15
… And Down Further …
RHK cuts NA Optical Transport Market Outlook by another 40% in September.
16
… And Inventories Build Up
Alcatel
Ciena
Cisco
Lucent
Nortel
Days of Inventory
On March 1
2 Year Avg % Difference
145.0
103.4
40
108.5
86.1
26
80.9
58.6
38
102.8
102.4
0
87.8
78.0
13
17
Carrier Capex Weakness Trickles Down To Components
Agere
Alcatel O
Avanex
Corning
Finisar
JDSU
Revenue Growth Comparison ($M)
TTM
CY01E
% Change
% Ch. 00/99
5,021
3,616
-28
27
526
472
-10
144
131
97
-26
7,888
7,824
6,995
-11
60
196
176
-10
89
3,233
2,336
-28
na
18
Optical Equipment Stocks Have Been Hammered in 2001
 Since January 2001:
 JPM Equipment Index down 60%. (Includes all major telecom equipment
suppliers.)
 JPM Component Index down 55%. (Includes all major telecom optical and
electronic component suppliers.)
 Nasdaq off 25%
19
Everyone Is Unhappy
 Carriers – Service spending by enterprise customers in a slump.
 System OEMs – Carrier demand is slow.
 Components Suppliers – OEM customers are sick.
 Investment Banks – No equity market for IPOs. Little equity power for M&A, and
everyone hoarding cash.
 VCs – Where are the exits?
20
Looking Forward
21
The Bad And The Good
 The Bad:
–
–
–
Aggregate carrier spending could be flat to down for next 1-4 years, due to recent
capex/revenue imbalance
Aggregate long-haul spending will be flat to down given over-investment and capacity glut
No catalyst (killer application or economic recovery) on near term horizon to re-accelerate
spending
 The Good:
–
–
–
–
–
–
Optical networking helps improve the capex/revenue imbalance
Carriers’ restrained spending will favor optical networking equipment
No capacity glut in access or metro
Inventory overhang should dissipate by mid-02
Long-term outlook remains unchanged: unyielding bandwidth expansion and shifting traffic
dynamics will force the adoption of an optical networking model
Installed base of optical systems at early stage of technology maturity curve
22
No Near-Term Turnaround In Carrier Spending Expected
 Negative spending growth expected for all services except ILECs through 2002;
 ILEC spending flat through 2002
 Long haul carriers and bandwidth wholesellers will take longest to rebound
TWP, 08/01
23
Carriers Will Work Capex/Sales Ratios Down To Previous
Levels
24
No Catalyst On Near Term Horizon To Re-accelerate Spending
 Internet traffic volumes still double annually, but growth down by more than 40%
from 2000.
 Video-on-demand too expensive
 Interactive gaming too slow, too expensive
 DSL, cable modem deployment growth plodding
 Bundled services and distributed storage the next killer apps??
25
Gauging The Timing Of A Recovery
Component Vendors
Rebound in components
market could be more
than 2 year out.
Equipment Vendors
Service Providers
Enterprise, Residence
2001
2002
System OEM’s health improves
Inventory overhang dissipates – weak impact
Demand for next gen components increases
- strong impact
Increased integration strengthens margins
Carrier’s financial health improves
Metro bottleneck inhibits carrier revenue growth
Capacity glut in long haul begins to dissipate
Next gen solutions are rolled out, selected
Carriers re-initiate spending programs
Enterprise spending recovers
New differentiated services emerge
Revenue/Capex ratio stabilizes. ROI improves
Capital markets open up
Regulation eases
Global market demand recovers: manufacturing, services
Corporate profits improve
Corporate hiring improves/stabilizes
Interest rates remain low
Capex spending rebounds
2003
Sept 01
26
2004
The Good: Optical Networking Helps Improve the
Capex/Revenue Imbalance …
 Lowers the hardware cost/bit by 50% or more over legacy SONET gear, which
represented 80% of transmission equipment spending in 2000 (CIBC, 7/01).
 Provides a scalable platform - pay as you go – that lowers first installed cost.
 Promises to lower
operating costs by
simplifying
provisioning and
maintenance
CIBC 7/01
27
… While Future-Proofing The Network
 Scales in step with growing capacity needs
 Transparent, so accommodates any transmission format and service type,
including wavelength services
 Reduces need for overlay networks
28
Carrier Spending Is Slowing, But The Distribution Will Slant
Towards Optical Networking
Global Capex
Spending
Annual
Growth Rates
Total
$370B
Optical
36%
$306B
21%
$47B
2000
$64B
2001
Total Capex
Optical Capex
RHK, 2/01
29
Top Down Forecast Suggests Long-Term Market Growth
Remains Robust …
CSFB, 09/01
With these updated numbers, redo chart on next slide. 9-17-01
30
… Even By More Conservative Forecasting Assumptions
14
60
Systems Market
16
12
Systems
50
10
40
8
Components
30
6
20
4
10
2
0
0
2000
2001
2002
2003
Service growth held flat through 2004
Capex held to 19-20% of revenue through 2006, not 23%
Optics percent of total capex held to 30% by 2006, not 35%
31
2004
2005
2006
Components Market
70
Top Down Forecast of Optical Networking
Markets ($B)
Optical Networking Still In Its Infancy
Optical Networking Still In Its Early Years
IBM 1400
Computer
Apple I
Computer
MS
Windows
Netscape
Navigator
Intel 286
Intel 4004
Semiconductors
1950
1960
1970
1980
1990
2000
1990
2000
2010
2020
2030
2040
Optical components
Ciena MW
1600
32
Venture Investors Continue To See Strong Potential In Optical
Networking
Aggregate Value of Venture Investments
Number of Investments
Aggregate Value of Investments ($M)
Median Size of Investment ($M)
1998
1999
2000
2001 YTD
22
39
110
73
$138
$479
$2,626
$1,907
$5
$12
$19
$13
Broadview, 8/01
33
Identifying The Pain
34
To Lower Costs, Carriers Need To Simplify Their Networks
Existing networks are
expensive:
Transparent networks should
be less expensive:
To design: multiple protocols
to support: ATM, IP, TDM
To provision: multiple layers to
interface and manage
To maintain: large footprint and
high box count
To operate: Each O/E/O
interface and box interconnect
provides a failure point
To design: single protocol –
wavelengths
To provision: single physical
layer
To maintain – low box count
To operate - no O/E/O
conversions
Shift To
Transparency
What Is Needed?
True optical switching devices
Adaptive, intelligent solutions
Modular, scalable systems
Manageable optical architectures
Low cost, high-volume, automated
manufacturing
35
The Impact Of Network Simplification On Hardware Cost
 Consider a theoretical LH core network with 15 nodes, populated with 64-channel
DWDM systems; each channel at OC-192.
Network Element
Legacy
SONET/WDM
System
Next-Gen
SONET/WDM
System
Opaque Optical
Networking System
DCS
ONS
OC-192 terminals
WDM terminals
NG DCS/ADMs
Space
Power
15
0
1,920
30
0
3,930 sq ft
8.0 MW
0
0
0
30
960
505 sq ft
1.5 MW
0
15
0
30
0
105 sq ft
150 kW
Total Initial Cost
$300m
$160m
$90m
Typical vendors
Alcatel, Fujitsu,
Nortel, Lucent, NEC
Ciena/Cyras,
Cisco/Cerent, White
Rock
Ciena, Sycamore,
Tellium, Brightlink
JP Morgan, 5/01
36
Simplification Through Optics: Promising But Elusive. Many
Hurdles, Many Opportunities
Metro Access pains:
Metro Core pains:
LH Core pains:
High system cost
No QoS for wavelength services
Span length limitations
I/O is too slow, to bulky
 No automatic protection and
Noise accumulation
Installing residential fiber
networks is expensive
provisioning
Nonlinear signal effects
Optical add/drop nodes not
Bandwidth limitations (bit rate and
reconfigurable
channel count)
No adaptive optical power
No automatic protection switching
management
System throughput, port density
Bandwidth limitations
OXC
O-ADM, OXC
37
Points Of Pain – The Transition To Optics In Long Haul
Where it hurts
The prescription
Complication
Span limitations
(600 km)
Next generation amplifiers, involving
higher powers and distributed
amplification. Higher sensitivity
receivers. New modulation formats.
Specialty fiber and pump laser
technologies immature. Highsensitivity receivers expensive.
Channel limitations
(80 channels)
Tighter channel spacing and wide band
accessibility
Filter technology slow to improve
and wider band amplifiers
immature
Noise accumulation
Adaptive dispersion compensation
Adaptive algorithms slow, devices
expensive, large, and lossy
Optical power
management is not
adaptive
Dynamic gain equalization and
management
Adaptive algorithms slow, devices
expensive, large, lossy, requiring
muxing/remuxing
Non-linear signal
interaction
Solutions supporting lower peak and
average transmission signal power
Specialty fiber and pump laser
technologies immature
Bit rate limitations
(10 Gb/s)
Higher speed transceivers
High speed optics and driver chips
immature, as are alternative
modulation solutions
No automatic protection
switching
High-speed optical performance
monitoring, network management, and
optical switching
Commercial solutions for OPM not
available. Optical switches remain
large and expensive.
Channel blocking due to
 assignment conflicts
Tunable lasers and all-optical
wavelength converters
Low yields, low power, limited
tuning range, expensive
System throughput, port
density
Transparent optical switching systems
and components
Switching engines are tough to
manufacture, qualify
38
Points Of Pain – The Transition To Optics In Metro Core And
Access
Where it hurts
The prescription
Complication
No QoS for lambda services
High-speed optical
performance monitoring
Commercial solutions for OPM not
available. Optical switches remain
large and expensive.
No automatic protection
switching
OPM, plus integrated
network management
Commercial solutions not available
Add/drop nodes are not
reconfigurable
Low cost wavelength
selective switches and
tunable filters. Tunable
lasers.
Technologies are immature: lossy,
power hungry, expensive, low yield,
unreliable
Optical power management is
not adaptive
Dynamic gain equalization
and management
Adaptive algorithms slow, devices
expensive, large, lossy, requiring
muxing/remuxing
Optical multiplexing is
expensive
Lower cost filter assemblies The filters are cheap, the assembly
is expensive
Transmitters/receivers are too
expensive, too bulky
Tunable lasers and low
cost, hot swappable
transmitters
Cost/bit of high reliability
Migrate to LAN-originated
circuit-based solutions remains protocols like Ethernet
expensive for access
39
Price points are difficult to hit, based
on low yields for tunables
Reliability of packet solutions is not
carrier class
Relieving The Pain
40
Pain Relief
Network Needs
Technology Responses
Next generation amplifiers, including
higher power amps, lower-cost
amplets, wider band amplifying, and
distributed amplification
Higher power EDFAs
Higher power pump lasers
Lower power EDFA amplets
SOAs
Raman amplifiers and lasers
Optical pulse reshaping and retiming
Dynamic gain equalization and
management
Dynamic gain equalizers
Amplifier arrays
High sensitivity receivers
APDs
Enhanced modulation formats
Soliton & other ULH solutions
O-TDM solutions
Multilevel transmission solutions
Tighter channel spacing
25-50 GHz WDM filters
Adaptive dispersion compensation
Adaptive dispersion compensators
(chromatic and PMD)
Higher speed transceivers
40 Gb/s modulators
40 Gb/s transceivers
High-speed optical performance
monitoring, network management
Optical performance monitoring
network management
Tunable lasers and all-optical
wavelength converters
Long reach tunable lasers
optical wavelength converters
41
Pain Relief (cont.)
Network Needs
Technology Responses
Optical switching systems
Optical cross-connect systems
Optical add/drop systems
High-speed, high finesse optical
performance monitoring
Optical switches and tunable
filters
Lower cost filter assemblies
Tunable lasers and low cost, hot
swappable transmitters
Optical performance monitoring
MEMs, FBGs, bubble, liquid crystal,
EO and TO devices, SOAs, other
technologies
CWDM/TFF, AWGs, bulk gratings
Shorter reach tunable lasers
Short and long wavelength VCSELs
SR and VSR transceivers,
transponders
42
Component Integration Should Be A Key Element Of Any
Ongoing Optics Investment
Discrete Components
 Single components produced by
multiple vendors
 Volume manufacturability becomes as
important as performance
 Market leadership determined by
price. Low sustainable margins.
 Off-shore manufacturing becomes
Modules
 Vendors move up the food chain, easing
OEM’s task of systems integration
 Value is less in science and more in
automated assembly and packaging
design
 Optics and electronics expertise and
integration both critical
Subsystems
 Allows OEM’s to focus on software/
hardware integration and channel
management
 Understanding network issues become
critical, even though not selling directly
to carriers
 Gross margins approximate systems
norm





Couplers
Isolators
Interleavers
WDM discretes
Laser, receiver diodes





Transceivers
Channel Monitors
Switch engines
VOAs



Optical amplifiers
Tunable TxRx
Optical cross-connects
and add/drops
WDM transponders
CSFB, 8/01
43
The Impact Of Market Timing On Investment Decisions
Components
Winter of Despair
Spring of Hope
Systems
Market dominated by:
Market dominated by:
Dynamic, automated
static systems
systems
discrete components
Integrated, tunable
components
2000
2001
2002
2003
2004
2005
Carriers slow spending
Carriers spending re-bounds
Work through inventory
Inventory of older gen equipment has
Focus on risk aversion
Little appetite for new gen
systems
Little demand for new gen
components
been exhausted
New gen solutions will enable dramatic
boost to network performance, drop in
cost/bit
Opportunity for novel new component
technologies. Incremental upgrades to
older technologies won’t keep up.
44
2006
Investment Conclusions
 Invest selectively now for the Spring of Hope
 Focus on early stage companies that provide new approaches to network
optimization:
–
–
–
–
–
–
Low cost
Integration
Tunable, adaptive
Automated operation
High bandwidth
Transparency
 Avoid later-stage companies that provide incremental improvements to older
generation equipment. If budget assumes substantial ramp in 2002, 2003 revenue,
be wary.
–
Give little weight to OEM penetration, given the uncertainty of equipment markets and
players
 Survive the Winter of Despair
–
–
–
See funding well into 2003
Keep burn low
Avoid high capitalization companies that are vulnerable to extended Winter
45