What Corvis Needs: A Couple More Customers


For months now, while optical heavyweights Nortel Networks and Lucent took a beating, some smaller optical players were having a ball. But now the happy times are over for all. Witness one of the world's hottest optical startups, Corvis Corp. (CORV).

In the past few downbeat months, the company has had a healthy share of good news: In January, Corvis shares rose on the annoucement that Williams Communications, a voice data and internet service provider, would expand its two-year, $200 million contract with Corvis to a five-year, $300 million agreement. And on Apr. 26, Qwest Communications, which has been testing Corvis's equipment for a $150 million, two-year contract, announced it would build its network using Corvis' gear. That would give it three paying customers.

Corvis even surprised the Street with strong first-quarter earnings,

announced after the markets closed on Apr. 26. The Columbia (Md.)-based

company reported revenues of $84.1 million -- an 82.8% increase over the

previous quarter. "The revenue was well above what we were estimating,"

says David Heger, analyst with A.G. Edwards & Sons. Net loss for the three months ended March totaled $23 million, or 7 cents per share, which was in line with most analysts' estimates, according to First Call.

ROCKY FUTURE. But here the good news ends. In fact, Corvis shares fell from $7.80 to $6.50 in the early trading the day after the fireworks earnings announcement. And the company was hit with a downgrade from Salomon Smith Barney. What's going on? Corvis is about to feel the heat from the economic slowdown. With no new customers in sight, rising price pressures, and possible cutbacks in orders, the future looks rocky for the rest of the year.

It's not Corvis' products, which are still regarded as state of the art. The star of its model lineup is a switch capable of transmitting huge amounts of voice and data traffic over long distances more quickly than standard electronic switches. Trouble is, Corvis' biggest customer, communications services provider Broadwing Inc., recently announced that it would decrease its spending on long-haul, backbone equipment -- Corvis' specialty -- for the rest of the year.

Last quarter, Broadwing spent $95 million on such equipment, and Corvis got $65 million of that, says Alex Henderson, analyst with Salomon Smith Barney. But Broadwing plans to spend only $50 million for the rest of the year because its network all but built out. Corvis might see only $30 million to $35 million from Broadwing in the coming quarters, estimates Henderson.

COMPELLING MATH. Same with Williams -- Corvis' second-largest customer, Henderson says. Given that these two customers made up 100% of Corvis' first-quarter revenue, even new orders from Qwest, which could start trickling in as early as second quarter, won't make up the revenue gap, he adds. "The math is compelling," he says. Henderson has downgraded the stock to accumulate.

Seth Spalding, an analyst with investment bank Epoch Partners, still has a "sell on the news" rating on Corvis. But he says Broadwing and Williams now have much less of an incentive to support Corvis through such economic turbulence, The reason: Their equity stakes in the company have shriveled. Corvis entered 2001 with $580 million in contractual backlog from its customers. But Corvis' stock price -- hovering around $20 in January -- has now fallen 92% since it hit a high of $114.75 per share at the time of the company's initial public offering in July, 2000. In fact, Broadwing unloaded a quarter of its minority interest in Corvis in March.

Both Broadwing and Williams say they're sticking with Corvis. Says Broadwing Chief of Staff Thomas Osha: "The relationship between Broadwing and Corvis is very strong. We view the agreement [with the company] more like a partnership rather than a deadline contract." A Williams spokesperson says it reviews all of its vendors based on technology and prices -- two Corvis strong suits. And Corvis CEO David Huber told investors in a conference call on Apr. 26 says that "our relationship with these industry leaders continues to grow stronger."

DOWNWARD PRESSURE. Such fealty is great. But asks Spalding: Where are the new clients? Corvis is still in the red and expects to post a net loss of 23 cents per share for 2001, according to First Call. It isn't expected to turn a profit until at least the first half of 2002. Meanwhile, competition in the telecom business is becoming cutthroat, putting downward pressure on pricing.

That rivalry is particularly strong in the optical-switching part of its business, acknowledges Huber. Price cuts are expected to reduce margins to significantly less than the 35% to 40% projected earlier, said Corvis Chief Financial Officer Anne Stuart in the conference call. The company would not offer guidance as to what the new margins might be. But the cuts will also likely affect any new contracts in the next few quarters.

Small wonder many think Corvis is in the hunt for a new customer in addition to Qwest. "We are aggressively pursuing new customers across the world," Huber said on Apr. 26. "But the current economic environment makes that difficult."

SLASHED SPENDING. Analysts believe the company may be in talks with long-distance carrier Global Crossing, Level3 Communications, or one of the European carriers, such as British Telecom. Getting a new customer could be key: Unless Corvis maintains its existing contracts and picks up at least one more customer, it might not be able to increase its revenues at an expected 42% per quarter, according to Epoch. The slowdown could be felt as soon as the fourth quarter of this year, estimates Heger.

To make its 2001 revenue projections of $315 million to $325 million, Corvis would have to severely cut its operating expenses for the year, from $250 million to $260 million projected earlier to $200 million to $210 million, said CFO Stuart. These cuts would affect all expense items, including research and development allocations, though "core research and development initiatives won't be affected," she said. The cuts could also affect the 1,625-employee company's staff expansion plans. Stuart would not provide the headcount the company anticipates having at yearend.

The bottom line: "The company is executing very well, but the market environment has gotten very difficult," says Jeff Lipton, analyst with J.P. Morgan Chase. First Call's poll gives the company a 1.6 rating, with 1 being a buy and 3 being a hold. Although analyst Heger still expects its stock to rise to $15 a share within 12 to 18 months, "Corvis is going to have a rough six months," says Giga's Slaby. Spalding believes investors should sell Corvis' shares as soon as a new customer is announced.

Corvis has opportunities to prove its worth, says Heger. And it has plenty of cash to burn: Even if it continues going through $200 million per year (Stuart said the company will decrease its burn rate), reserves would last four to five more years, he says. The question now: In an economic downturn and a sour market, will shareholders have the patience to stick with what was formerly one of the hottest startups in the optical realm? By Olga Kharif in New York


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