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While the dot-com Internet bubble might best be remembered for companies raising hundreds of millions of dollars based on flimsy business plans like free hand-delivery of gum (anyone else remember Kozmo.com?), the bubble took on many forms. Another key area of investor excitement during the bubble revolved around the companies creating the network equipment that would carry the massive amounts of data a growing Internet would create.
However, like companies creating websites that simply had no chance of profitability, dreams of booming equipment demand for Internet infrastructure proved to be more sizzle than steak. Companies overbuilt relative to the amount of data growth. Yet with the emergence of Internet video and other bandwidth-intensive fields, heavy-bandwidth equipment looks to be finally reaching the promise investors dreamed of a decade ago. Best of all for investors, even after impressive gains, there could still be untapped potential for stocks like Calix (NYSE: CALX ) , which toils away in an underfollowed area of telecom infrastructure.
The inevitable Internet video future
The state of bandwidth growth is usually summed up by Cisco's annual Visual Networking Index, which predicts that Internet traffic will quadruple between 2009 and 2014. The chart below illustrates the different areas driving the surge in traffic.
Source: Cisco Systems.
While there are several different segments in the chart, the sum of all forms of video should contribute 91% of traffic by 2014. The explosion in data comes largely thanks to huge technology advancements that have allowed the cost of streaming video to fall precipitously to the point of economic viability. It costs Netflix (Nasdaq: NFLX ) about two-and-a-half cents to stream a movie today, according to industry observer Dan Rayburn. In 1998, streaming a movie of equivalent quality would have cost Netflix $270 per film!
Given these pricing dynamics, it becomes much easier to understand why past data growth expectations were wildly inflated, while today's are much more reasonable.
But how to profit?
Optical networking is one of the areas that garnered increasing amounts of attention as the Internet data explosion hit investors' radars. Optical networks are ideally suited for high-bandwidth systems covering long distances. Companies ranging from component makers like JDS Uniphase (Nasdaq: JDSU ) to makers of backhaul equipment (a portion of the network benefitting from mobile demand) like Ciena (Nasdaq: CIEN ) have seen their stock prices soar over the past year.
However, despite all the attention paid to the backhaul and component portions of optical networking, a whole group of infrastructure companies across the telecommunications industry are also set to benefit. Broadly speaking, Infonetics research believes that "aggregate spending on broadband aggregation equipment, fiber-based access equipment, cable aggregation equipment, mobile backhaul equipment and carrier Ethernet equipment in North America [will increase] from $7.6 billion in 2009 to $11.2 billion in 2013 and worldwide from $35.9 billion in 2009 to $54.7 billion in 2013."
While that collection of industry segments might scare off anyone but hardened telecom executives, the point is that the process of moving high-speed data requires vastly different areas of communications equipment that should continue to see record business in the coming years.
To that end, Motley Fool co-founder Tom Gardner recently called out Calix, which serves a part of the broadband chain known as "access networks." While fiber might be best known for its ability to handle fast data transmission over long distances (longhaul), Calix's systems directly deal with the "local loop," directly connecting residences and businesses to their internet service provider's facilities.
While other parts of the broadband chain might get more attention than access networks, it's important to remember that bottlenecks at any point can drastically reduce performance for end residential and business users. This is where Calix comes in; the company has focused on an "advanced unified architecture" that greatly reduces the shortcomings of legacy access networks, which are proving incapable of handling next-generation demand.
Where are the catalysts?
Even though the market opportunity might seem obvious --telecoms need more capacity in the face of accelerating data use -- telecom equipment has historically been a difficult field for investors to profit from. Two major problems exist:
- Telecoms can exert extreme pricing power, especially in competitive fields.
- Historically, competition within regional markets has been light.
The second point has recently improved quite a bit for the equipment industry. Thanks to deregulation begun in the '90s, telecom companies that used to offer narrow services began to expand their reach into converged technologies. Witness Comcast (Nasdaq: CMCSA ) and Verizon (NYSE: VZ ) , two companies that used to compete in different segments, now fighting in many markets over triple-play packages that bundle not only Internet, but also phone and TV. This increased competition leads to companies wanting to better their networks through upgrades like Calix's Unified Access Systems.
The competition issue is a bit thornier. Calix's most direct competitor is Alcatel-Lucent (NYSE: ALU ) , a large conglomerate. Its superior size means Alcatel can cross-sell other equipment and offer service providers discounts by buying from its larger product portfolio. Also, its size creates an air of stability. Service providers can be wary of using smaller players that could struggle financially, leaving valuable portions of their infrastructure unsupported.
However, Calix has recently taken steps to address this problem. The company purchased rival Occam Networks to gain more scale and fill in its portfolio. Also, the company is led by Carl Russo, a longtime industry veteran. Since Calix largely competes on the technological superiority of its portfolio, realtive to that of larger rivals selling access-network products as one part of a larger fleet of goods, having a tested industry leader like Russo at the helm is invaluable to the company's ability to gain market share in a growing field.
The Foolish bottom line
There are definitely very real risks in Calix's attempts to carve out its niche in the access network field, so I feel Tom Gardner was onto something when he decided to start watching Calix, instead of formally recommending it. While the company has vast potential at the center of a data boom megatrend, it's also struggling to turn a profit in a highly competitive field. That doesn't mean Calix couldn't be a buy, but it does mean that understanding the advantages of Calix's products and leadership team is extremely important in assessing whether the company can reach its promise.
I'll keep following and writing about Calix. If you're interested in following along, make sure to add Calix or any of its main rivals to My Watchlist to stay updated.