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Is There Unused Capacity?

Clearly, a case can be made that there is and will be tremendous growth in demand and that the carriers now have much better economics for service deployment. The only remaining question is whether there is an excess of unused capacity that will limit capacity spending by the carriers.

This is an important measure, but one that is very difficult to gauge. Certainly, the 1990s were a period of explosive growth in capital investment, particularly towards the later part of the decade (see Exhibit 3). Major carriers, including AT&T, WorldCom, SBC, Verizon, Qwest or BellSouth, deployed thousands of miles of fiber throughout their networks. However, more than 50% of this fiber remains dark fiber (fiber that does not carry any traffic or does not have equipment at either end). Only when a fiber is "lit" (or utilized for carrying traffic) is it a potential revenue stream for the carrier.

However, the equipment is expensive and generally is not added by the telecommunications companies until needed. As a result, while there is ample fiber (e.g. dark fiber) capacity, we don’t believe there is much excess data capacity,
especially in the metro and access areas.

Conclusion

There is no question that the telecommunications industry is in a state of flux. Increased spending during the last several years has led to heightened expectations of revenue and earnings growth on all fronts, including the equipment and component vendors as well as the carriers.

Certain facts remain true:

• Traffic growth is real (whether voice, data or video) – Compounded Annualized Growth Rate over 100%
• End-user demand is real
• Carrier as well as enterprise focus is on revenue generating activities.

Those products that target these points should fare well going forward. The recent correction in the market should be viewed as an opportunity to identify the companies with both a real sustainable, competitive advantage and a clear value proposition. Over the long term, they will be the winners.

At Shaker Investments, our focus is to identify those companies in this transformation, including those focused on:

• Optical transport (Ciena)
• Internet routers and switches (Juniper Networks)
• Metro transport/access equipment (Redback Networks, Extreme Networks)
• Broadband access
• Component suppliers to the above (JDS Uniphase, Vitesse Semiconductor, Applied Micro Circuits, PMC-Sierra).

Although this piece focused on carrier activities, specifically of the major U.S. ILECs and IXCs (SBC, BellSouth, Verizon, Qwest, Sprint, WorldCom and AT&T), the enterprise customer is an important component of the telecom equipment equation. However, the growth drivers outlined for the carrier space also hold true for the enterprise space as well as the international markets.