An Optical Delusion?

By now the booms and busts of the Internet economy have taken on an almost seasonal aspect. Callow start-ups--initially apples in venture capitalists' eyes--become in a few short months rotten e-commerce or business-to-business fruit. Portals, community sites, e-commerce companies, business-to-business (B2B) verticals--all are Web sectors once hyped as the next big thing; all are Web sectors in which stock prices have gone off the cliff.

Perhaps tired of trying to pick sectors that will be Web winners, some investors and venture capitalists think they have found a way to bet the whole shebang--optical networking. That's the business of sending digital information via light waves rather than electronic signals, and it has emerged as the latest, greatest Internet investing trend. Which means that companies involved in any phase of optical networking have become hot stocks. Component makers, such as JDS Uniphase and Corning, and system designers, such as Juniper and Ciena, are each up more than 50% this year. Last Friday, despite a vicious market sell-off, Corvis, an optical-equipment maker, launched its IPO at $36; it closed at $85. Corvis has no revenue and three corporate customers. High-end router-and-switcher company Avici launched at $31; it hit $97.

The reasoning goes about like this: think of some of this year's biggest business stories--AOL's merging with Time Warner, Vivendi's acquiring Seagram, Napster's hijacking the music industry. They are all, in some sense, about devising more and creative ways to suck up bandwidth. Words, music, video, interactive TV--they're all data that have to go through the electronic plumbing of the network.

"It's the most fundamental level of demand creation," says Vinod Khosla, a partner at venture-capital firm Kleiner, Perkins. "Optical-networking companies are like Levi's. They're supplying jeans and tools to miners during the Gold Rush." The amount of data traversing the Web is doubling every three months, and as these merged-media entities offer fatter and better Web services, bandwidth demand should accelerate again.

What optical-networking companies do is provide the equipment--filters, amplifiers, converters--and systems to companies that are feverishly building out the Internet, such as Level 3, AT&T and Qwest. Although optical fibers that transmit light waves have been around since the 1970s, only in the past few years have companies like JDS Uniphase and Corning figured out how to send prodigious amounts of information through those fibers by dividing light waves into channels and then packing data into each channel. A single channel is like a light bulb going on and off 10 billion times a second, flashing the 0's and 1's of binary computer code down the fiber.

The technology is as tricky as it sounds, forcing component makers like JDS Uniphase and Corning, among others, to acquire those pieces of the tech puzzle they can't assemble in-house, using their richly valued stock as currency. Two weeks ago, industry leader JDS Uniphase bought fellow component maker SDL for $41 billion in stock. And last week Corning began talks to acquire Nortel's optical-components business for a staggering $100 billion. Negotiations broke off late in the week, in part because Nortel's optical assets were rising in value so rapidly.