Manic for metro: Optical companies bring in the bucks

Goodbye dot-coms, hello fiber optics. The large premium paid by Sycamore Networks for Sirocco Systems is just a sign of the times.

On Wall Street, the only IPOs generating any first-day spark have been optical equipment companies. Optical transport systems maker ONI Systems jumped 230% on June 1, giving the company a market capitalization of more than $10 billion on 122 million shares outstanding. On May 18, New Focus woke a slumbering IPO market by gaining 155% in its debut. The manufacturer of fiber amplifiers, tunable laser modules and other fiber optic components has a market capitalization of $4.9 billion.

At $2.9 billion, Sycamore's purchase of Sirocco cost about $23 million per employee - expensive, but in line with the market. Both Lucent Technologies and Nortel Networks paid $30 million per employee in buying Chromatis Networks and Xros, respectively.

Are these companies too highly valued? An earlier round of optical takeovers was just as, if not more, costly - Cisco Systems acquired Cerent for $6.9 billion, Nortel acquired Qtera for $3.25 billion and Redback Networks purchased Siara Systems for $4.3 billion.

"Highly valued is a relative term," said Fahri Diner, CEO of Qtera. "Nortel realized that it's all about having a six- to nine-month advantage over competitors - it's about establishing a footprint in the optical network."

Time to market is critical in addressing the optics space, making the high valuations warranted, said Sanjiv Wadhwani, principal at Dain Rauscher Wessels. "Optics is where the semiconductor industry was 25 to 30 years ago," Wadhwani said. "There is a huge wave of technology advancements still to come. Everybody wants to make sure they're in front of that."

In particular, products and companies addressing the metro portion of the fiber network are white hot. The metro core is projected to be a $2.3 billion market by 2004, according to Pioneer Consulting, while metro access will hit $17.3 billion by the same year. And while Nortel and Ciena dominate long-haul optics, the metro optics space is wide open, Wadhwani said.

"The business of being just a long-haul carrier is going away," said Near Margalit, founder and chief technology officer of Zaffire, a supplier of dense wave division multiplexing gear for the metro market. "You're looking at a wholesale swap of the telco infrastructure," Margalit said. "Companies are pulling out truckloads of equipment and replacing them with a single box."

Of course, optical start-ups are popping up like prairie dogs looking for a piece of the potential market, which could one day lead to a supply-demand dislocation, said Todd Brooks general partner at the Mayfield Fund. The metro space is big, but it will not support 30 or so companies, he said. "When the music stops, will there be a chair for every optical start-up?" Brooks asked.

In the meantime, though, it looks as if optical infrastructure start-ups will replace dot-coms as the darlings of Wall Street and the venture capital community. Corvis, which filed to go public on May 4 and is valued at $2 billion, could be the next big optical IPO. And many optical companies will be bought before reaching the public market.

"We expect [the next] phase of consolidation to tie IP routing and optical networking equipment companies together to build true end-to-end solutions," said a report by Greg Geiling, analyst at J.P. Morgan Securities. "We believe the first vendor with a commercially available, IP plus optical solution will have a significant advantage in the marketplace."