In my past column, I explained why a telecom rebound is likely to occur faster than most people expect: the continued explosive demand for bandwidth, the reopening of capital markets courtesy of lower interest rates, increased telecom revenues resulting from price increases for broadband services, and the fact that companies near the top of the supply chain are working through and / or scrapping inventory.
This begs the obvious question: During the current bust cycle, what are telecom equipment and component suppliers doing to prepare for the next boom? Why they’re slashing capacity in every imaginable way, that’s what they’re doing! By the end of the year, just as demand is picking up, most companies will have reduced capacity by 30% to 50%.
In other words, even with a modest recovery in demand, the industry is setting itself up for the biggest capacity crunch it has ever experienced.
And to make matters worse, during the next boom period, equipment and component manufacturers will be quite skeptical about adding capacity to satisfy demand. In the words of the great musical philosopher Ian Hunter, “My, my, my, my, once bitten, twice shy, babe.” This will exacerbate the component shortage problem through next year and well into 2003.
In the optical components industry, there’s another less obvious but equally compelling aspect to the coming capacity crunch. You see, even during the current “bust” period, research and development goes on. The next boom cycle will be based on a new generation of optical components. Each generation of optical components is more miniaturized than the previous generation, with tighter tolerances. We’re talking about parts so small and tolerances so tight that figuring out how to test and measure them is every bit as difficult as figuring out how to manufacture them. We’re talking about tolerances so tight that mere temperature variations within the manufacturing facility can affect yields or shut down the manufacturing process.
This means that each generation of optical components is more difficult to manufacture than the last. To meet the challenge, optical component manufacturers must purchase a new generation of capital equipment capable of producing and testing smaller components with tighter tolerances. And therein lies the problem folks. Optical component companies should be purchasing this equipment now and developing their process capabilities, but they aren’t, because the current business downturn has caused optical component manufacturers to delay capital equipment purchases. When these companies begin receiving production orders for the next generation of components, they will be ill equipped to meet demand. Oh sure, these companies can use their old equipment to produce and test the new generation of components, but cycle times will be longer and yields will be lower, exacerbating the capacity crunch.
What does this all mean? It means that the big winners in the next boom cycle will be the few companies that have the guts to spend money during the current bust cycle.
And it means that a year from now, optical components companies will once again be receiving premium prices for selling their most precious commodity of all: capacity.
It would be nice in some ways if we could somehow extricate ourselves from the boom and bust cycle. The impact of firing and hiring cycles on the economy and on productivity could be eliminated.
On the other hand, the ability to recognize shifts in the business cycle provides opportunities for investors. The market, being an anticipatory animal, will begin to recover six months before the beginning of the next boom, and will begin to collapse six months before the end.
So how do you recognize the beginning or end of a boom or bust period?
One way to recognize shifts in the cycle is to observe analyst ratings. When your stock is at $150 and all of the analysts are screaming “buy”, its time to sell. The “strong buy” rating is analyst code for “buy my shares at the top because they’re about to go down.” Conversely, when these same analysts downgrade the same stocks when they are trading at $20, its time to buy. Downgrades are analyst code for “sell me your shares cheap because they’re about to go up.” And in case you haven’t noticed, analysts have been downgrading technology stocks like crazy over the last few months.
Going back to the topic of capacity, another way to recognize shifts in the business cycle is to analyze changes in capacity. When companies talk about their plans to quadruple capacity every 18 months, you’re at the top of the boom period. It’s a sure thing that supply is about to exceed demand. Conversely, when companies cut capacity by 50%, you’re at the bottom of the bust period. And that’s where we are now.
Copyright 2001 e-Broadband News. All rights reserved. E-Broadband News provides readers with news, commentary, and analysis pertaining to companies whose products and services increase bandwidth and storewidth for faster internet access.
