The Day Ahead: Oplink IPO set to soar, but beware

Relationship between Oplink and Lucent worth a close look

Commentary: The success of the Oplink Communications initial public offering is a given -- fibre optic companies dominate the top IPOs so far this year. But that doesn't mean you shouldn't do a little homework regarding the company's relationship with Lucent.

Oplink, which provides integrated fibre optic components, priced 13.7 million shares at $18, the top of its revised range of $16 to $18. The company upped its IPO price range from $14 to $16, an increase from the original range of $10 to $12. Robertson Stephens is the lead underwriter.

Given Wall Street's fascination with everything fiber optic, the first day runup of Oplink is almost a no brainer. Rivals Avanex and New Focus are two young companies that have made a big splash on Wall Street.

But you should keep an eye on Oplink's relationship with Lucent Technologies.

The fact that Oplink relied on Lucent for 42.6 percent of its revenue for the year ending 30 June isn't that surprising. Many fibre optic companies rely on a handful of big customers to prop up lofty market capitalisations.

So why the worry? Lucent has told Oplink that it "may decrease and eventually discontinue incorporating one of our optical components into some of its products over the next two years," Oplink said in its regulatory filings.

Lucent isn't thinking about discontinuing any old component -- it's a component that accounted for more than 28 percent of Oplink's annual sales. For the year ending 30 June, Oplink reported sales of $39m and a loss of $25.6m.

ZDII was scheduled to interview Oplink management later today, but management had to cancel on the advice of counsel. Oplink didn't want to appear to be hyping its stock given its pre-IPO press. Lucent would have been one of our first questions.

The Lucent decision on Oplink's component could have big implications for a young company that doesn't have a diversified customer base. Three customers -- Lucent, Sycamore Networks and JDS Uniphase -- account for 68.9 percent of Oplink's sales.

Specifically, Oplink said it sells to three Lucent divisions that make their own purchasing decisions. Sales to Lucent's Optical Network Group, Optical Electronics Group and Bell Labs accounted for 31.9 percent, 10.3 percent and 0.4 percent of 2000 sales, respectively.

Oplink also recognizes revenue from Lucent in a different manner. For all customers except Lucent, Oplink recognises revenue as soon as its products ship to customers. Lucent gets shipments on consignment basis, which means Oplink doesn't recognise revenue until Lucent accepts the products for use. Luckily for Oplink, Lucent accepts products within one to two months after shipment.

Lucent's consignment arrangement may not seem to be a big deal, but if Oplink has to sprint to make a quarter, it can't afford having Lucent holding things back.

The other main issue facing Oplink is competition.

It's clearly boom time for fibre optic companies, but the dynamic in the industry is changing rapidly.

Consolidation is pitting companies like Oplink against giants. Oplink cites Avanex, Ciena, Lucent, New Focus, Nortel and JDS Uniphase, which acquired E-Tek and plans to acquire SDL, as competition. The catch is the giants -- even Oplink customers -- are gobbling up the smaller players and posing a threat to the company.

"We believe that we primarily compete with diversified suppliers, such as Corning, JDS Uniphase, Lucent and Nortel, for the majority of our product line and to a lesser extent with niche players that offer more limited product lines," said Oplink.

Oplink, which will count Cisco as a shareholder after the IPO, noted seven big fibre optic mergers and reckoned more consolidation is on the way. That fact is likely to ding average selling prices.

JDS Uniphase is an example of how the industry is changing. JDS accounted for 10.6 percent of Oplink's 2000 sales, but it acquired E-Tek, which has a patent infringement suit against Oplink. Meanwhile, Lucent and Ciena are developing new technologies for wavelength division multiplexers that could hurt Oplink.

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