I’ve noticed a common trend during conversations with investors and analysts about the state of the optics market. People seem to be staking their hopes on 10G as the growth driver for the industry. I firmly believe this is true, but people are assuming the gains will be evenly distributed among all players. Here are the common misconceptions:
Video is Driving 10GbE
This is by far the most over-used and misdirected belief and causes me physical pain when I hear it. Yes, video is playing a major role in the expansion of WDM transport networks. Yes, most of these new links are 10G. But much more growth is coming from the datacenter as bladeservers and computing infrastructure transition to 10GbE. Companies like Broadcom are driving down the cost of putting 10GbE in servers, and subsequently will drive demand for 10GbE switching equipment. Other trends such as re-using the 10GbE standard for datacenter storage interconnect amplify this trend.
At best, 100k new 10GbE connections will be deployed in the core network in 2007. Compare that with the 400k or so modules Cisco alone will sell in the same timeframe. In 2008 the gap grows much larger.
But everybody understands YouTube, so video remains the lip-synching poster boy.
10G is One Market
Few bother to drill down into the innards of module types and specifications to understand product mix, and are quick to dismiss the alphabet soup of module types and laser reach specifications. This is a huge mistake as the majority of unit volume gain in the next 5 years will come in a narrow segment of product and reach types.
The 10G optical market is really several different markets with little or no relationship to each other in terms of cost, market demand, competitive pressure, and growth. Little things, like the tendency for enterprises to deploy OM-3 fiber have an enormous impact on product mix.
Incumbent 10G Suppliers Will Benefit
Some existing suppliers will do well, but the mistaken view that 10G is one market drives investors to believe all companies supplying this market will benefit. To borrow a much abused term, the distribution of growth in the 10G market is ‘lumpy’.
Opnext (OPXT) makes great hay about the importance of the 10G transition to their business and justifiably so given they are top supplier to Cisco for all types of 10G modules. While it is impressive that Opnext (as well as Intel (INTC)) supply the bulk of the volume today, it isn’t clear that they have adapted their supply chain for the demands of tomorrow.
My belief is virtually all unit volume growth will be in the low-cost, short-reach segments of the market, a market characterized by brutal price competition and 20-30% gross margins. Vertically integrated companies will be positioned best when volume ramps. Opnext is a somewhat vertically integrated manufacturer of long wavelength modules but heavily outsources both components and manufacturing of short reach modules.
It would not surprise me to see Opnext acquire a VCSEL manufacturer itself to remain competitive as the short reach market moves to higher volumes. I also believe this was the primary justification for JDS Uniphase’s (JDSU) acquisition of Picolight. (see “Why JDSU Bought Picolight“).
Such an acquisition still leaves both companies with a cost structure unsuitable to high volume commodity production.
I believe Finisar (FNSR) is the best example of a company well adapted to such a commodity environment as they are by far the most vertically integrated manufacturer of these types of components.
It will be interesting to see how all companies adjust in the volume shift in the 10G market. Perhaps Opnext decides to focus exclusively on long wavelength products, like they already have at 2.5G.
SFP+ is a key growth driver
SFP+ is a new low-cost 10GbE form factor and is a hot buzzword. It will indeed have a major impact on the market and is the key battleground in the competition between optics and copper interconnect. Industry insider consensus is SFP+ will not be ready for prime time in 2008 and I agree.
This is one trend where I admit I could be wrong as Cisco (CSCO) could change the whole equation quite abruptly. Cisco itself indicates only a small fraction of the modules it buys in 2008 will be SFP+, but doubts linger in my mind.
As readers know, I believe Cisco derives enormous profits from reselling optical modules. The transition to SFP+ is critical to Cisco for two reasons.
I am nervous betting against Cisco’s desire to make money and retain hegemony.
Copper (10GBase-T) isn’t a factor this time
Jury is still out on this one. One thing for sure- it shouldn’t be a factor until 2011 or so and faces significant technology headwinds. 1GbE optical component growth stalled in late 2004 as it could not match the per port costs of Gigabit Ethernet over copper. We shall see if this time is different.
Author is long Finisar.
… and I vow to torture a small animal in my office every time I hear or read the words “Video” and “Explosion” used in the same sentence. You, your Marcom group, and your conscience have been forewarned. (Just Kidding.)