High tech's biggest trends — the smartphone and tablet explosions, cloud computing and video distribution — are sparking investment in fiber-optic networking equipment for the first time in more than a decade.
As a result, providers of fiber-optical networking gear are diving into what promises to be a multiyear growth phase, enabling a global transition to what is known as the 100G network, a faster, higher-capacity replacement for the decade-old 10G platform.
100G, also known as 100-gigabit Ethernet, is an industry standard that defines a technology for serving up large doses of data, voice and video content at high speeds.
The case for more bandwidth is simple: Internet traffic, much of which travels across fiber networks, has doubled every year for the past five years, according to Cisco (CSCO) . The bulk of the current fiber network was built in the late 1990s to support the emerging Internet boom. The result: Those old "pipes" that move data and communications traffic from city-to-city and across continents are getting clogged.
Nothing irritates mobile customers like dropped phone calls or lagging networks. So big telecom operators such as AT&T (T), Verizon (VZ), British Telecom (BT) and China Mobile (CHL) are upgrading their networks to hold existing customers as well as seize new and expanding market share.
These carriers are planning to spend billions in order to upgrade networks to 100G speeds over several years, a campaign begun in the U.S. in 2011.
"Each year the carriers look for ways to innovate and get greater productivity," said Andrew Schmitt, optical analyst at Infonetics Research. "Moving to 100G is a big jump, but they have to do it to remain competitive.
The fiber-optic expansion is also being driven by wholesale telecom carriers such as Level 3 Communications (LVLT) and Internet network service providers like Equinix (EQIX). Tech giants such as Google (GOOG), Amazon (AMZN) and Microsoft (MSFT) come from another angle, investing heavily to build and expand massive data networks.
In the second quarter Google spent $1.6 billion on data center expansion. It was the third consecutive quarter the search engine giant doled out more than $1 billion on data centers and servers.
Complex Field Of Players, Tasks
Fiber-optic infrastructure is a big territory that involves several of the 197 industry groups tracked by IBD. The Telecom-Fiber Optics group ranked No. 3 among those groups Friday, up from No. 105 at the start of the second quarter. It includes Ciena (CIEN), JDS Uniphase (JDSU), Finisar (FNSR) and Infinera (INFN).
Companies in the Telecom-Infrastructure group also have a big piece of the optic expansion. That group includes Alcatel-Lucent (ALU) and Ericsson (ERIC) and ranked No. 32 Friday.
Another major provider in this field is China-based Huawei, which does not trade on U.S. exchanges.
Dmitry Netis, analyst with William Blair, told IBD the major trends causing the data explosion start with the massive growth in broadband mobile devices. Another leading culprit is the growth in video fueled by Netflix (NFLX) and Google's YouTube.
A third factor is the emergence of cloud computing, the migration of software and computing services from independent networks to more efficient, online providers. That shift underpins a large portion of growth from companies such as Google and Amazon, as well as software-as-a-service (SaaS) providers, such as Salesforce.com (CRM).
There are countless other advances pumping up the pressure. Machine-to-machine communications, for example, such as connected utility-metering systems, remote monitoring services and point-of-sale retail terminals.
"This is going to be a multi-year rollout and we are just in the beginning stages," said Netis. "We're just now starting to see the impact of this in the earnings reports of Ciena, Infinera and others.
Analysts hustled to upgrade outlooks for Finisar, as shares surged 15% Wednesday after pre-announcing better-than-expected fiscal first-quarter sales late Tuesday.
The results were driven by strong demand for 10G, 40G and 100G Ethernet transceivers, according to a note from RBC Capital markets. Leading customers include Cisco, EMC (EMC), Juniper (JNPR), Brocade (BRCD) and Ciena.
Shift To 100G
When Ciena reported last month, CEO and President Gary Smith addressed the fundamental shift toward 100G in a conference call with analysts.
"Networks are now being impacted by tremendous growth," Smith said, acknowledging to the complexity of the challenge. "This is a fundamental re-architecturing of the network with multiple elements to it.
The technologies involved with the 100G upgrade are technically intense. This includes wavelength division multiplexing technology. WDM funnels a number of optical carrier signals into a single fiber line, using different wavelengths of laser light.
WDM has enabled significant growth in network traffic while reducing costs.
Another category is synchronous optical networking and synchronous digital hierarchy. Known as SONET/SDH, it is an older technology still in widespread use but seen as declining in the market.
Another category refers to optical transport networks. OTNs provide optical switching, routing, management and supervisory services across multiple fiber networks, providing great functionality. OTN switching helps to maximize the capacity of 100G networks.
Ciena and Infinera primarily compete in the optical network equipment segment of the market, which includes WDM and SONET/SDH. Large competitors in this field include Huawei and Alcatel-Lucent.
Optical components is another big market segment. This includes lasers, switches, splitters and other parts used to build fiber-optics communications systems. Finisar is the leader in this market, followed by Japan-based Oclaro, then JDS Uniphase.
Resuscitated Industry Cycle
Spending on optical networking and components is projected to reach $13 billion this year and is growing at a rate of about $1 billion a year, Netis said.
The 100G expansion is likely to result in the continued disruption of weaker competitors. The optical equipment industry experienced substantial consolidation in the past decade.
"This is a sector that has been out of favor for quite some time," said Netis. "It's an underappreciated sector in tech that is now seeing a new cycle starting.
More consolidation is expected as vendors face-off on the new battlefront.
Here's a rundown on some of the largest companies in IBD's Telecom-Fiber Optics industry group: • Ciena Revenue of $1.8 billion for its fiscal 2012 year ended Oct. 31 rose 6% from the prior year. This year the consensus estimate is for revenue of $2 billion, up 11%. Earnings per share before special items, based on consensus estimates of analysts polled by Thomson Reuters, is for 53 cents, vs. a loss of 24 cents a year ago.
According to Netis, Ciena has established itself as a leader in the optical network infrastructure market, with a combination of network transport and switching and optical networking gear that extends across all network applications. It is a strategic partner with many of the world's largest operators, including AT&T, Verizon, British Telecom and Deutsche Telekom.
• Infinera Revenue in 2012 rose 8% to $438 million. In 2013 the consensus estimate is for revenue of $544.4 million, up 24%. EPS minus items is projected to be a loss of 1 cent, compared with a 39-cent loss a year before.
The company said in its last earnings statement that it has "the world's only commercially deployed large-scale PIC," or photonic integrated circuit, used inside optical transport platforms. Similar to how the integrated circuit changed the dynamics of the computing industry, Infinera thinks its PIC will have a similar impact on the optical networking industry. It's a point that Netis agrees with, saying Infinera's PIC "is a game changer because of its cost, scalability and speed," which he believes will take years for competitors to replicate.
Revenue of $934 million for its fiscal 2013 year ended April 28 fell 2% from the prior year.
Analysts boosted fiscal 2014 revenue projections to 17% from 7%, and EPS forecasts to $1.20, an 88% gain, up from $1.02, after the company's solid first quarter.
Q1 results may have received a boost from the seasonally strong period, and from Cisco "front-loading" some of its purchases, analyst Mark Sue of RBC Capital said in a note.
The vertically integrated nature of Finisar's business gives significant operating leverage to Finisar's financial model, Sue wrote. But there is also the threat of major customers like Cisco beginning to develop and produce their own gear.
• JDS Uniphase: Revenue in fiscal 2012 fell 7% to $1.68 billion for its fiscal year ended June 30. The company is expected to report fiscal 2013 results on Aug. 13. The consensus revenue estimate is $1.68 billion, like last year. EPS of 56 cents compares with 60 cents the year before. JDS was one of the few survivors of the year 2000 crash of optical networking companies, and has since reinvented itself, wrote Netis.