BOOK EXCERPT: Bagnall’s Telecom Tornado reveals true tech tales

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Telecom Tornado is the distillation of three decades of journalism by former  Ottawa Citizen associate business editor James Bagnall. Best known for his coverage of high-tech’s raucous rise and gut-churning collapse, Bagnall delves deeply into stories involving fraud, failed prosecutions, misguided project management in government, and business leaders who suffered from mental illness.

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I caught my first glimpse of the telecom tornado on February 7, 1996. It was the day I returned to Ottawa from Utah where I had visited the nearly empty headquarters of WordPerfect — the once-dominant software company recently acquired by Michael Cowpland.

I had been expecting a follow-up call from a Corel executive but when I picked up the phone, I was surprised to find Jozef Straus on the line.

Although it was our first conversation, I was aware the Czech-born scientist was CEO of Ottawa-based JDS Fitel, which made fibre-optic components for building high-speed communications networks. The company employed a few hundred people, nearly all in the Ottawa area. It was as private and low-profile as they come.

Straus was not used to dealing with journalists and seemed uncertain at first about how to proceed. “Look at the newswires tomorrow,” Straus said finally, declining to answer my follow-up queries.

This was Straus’s idea of reaching out. Those newswires the next day revealed JDS Fitel had filed paperwork for issuing shares to the public for the first time.

The preliminary prospectus offered a bare-bones history of the 15-year-old firm, and basic information about its founders, managers, and customers. Straus wanted to be sure the investing public knew at least something about his business, which was profitable and growing steadily.

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What neither of us grasped at the time was the strength of the forces about to be unleashed.

A telecom boom of unprecedented scale was forming. It would create hundreds of billions of dollars in shareholder capital out of thin air, transform the city’s skyline and briefly upend the idea of Ottawa as a government town.

One of the boom’s most significant catalysts — the U.S. Telecommunications Act of 1996 — was signed the same day JDS Fitel filed its paperwork.

It was the first major rewriting of American telecommunications law in more than 60 years. The goal was to make the industry more competitive, promote new technologies and reduce prices for consumers.

However, the immediate effect of the legislation was to produce a new class of carriers eager to build higher-speed communications networks, many of them from scratch. The upstarts paid for it with venture capital, junk bonds and proceeds from a booming stock market. Established carriers such as AT&T and MCI Communications concluded they had to follow suit.

The modernization and expansion of communications systems that might have occurred over a decade would be compressed into a few short, frenetic years.

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Nowhere did this have a bigger impact than in Ottawa, the headquarters for JDS Fitel and Bell-Northern Research, the research arm of Northern Telecom (soon to become Nortel Networks).

These firms had spent years in the wilderness, patiently creating the building blocks for fibre-optic networks. JDS Fitel developed components. Nortel assembled these and other technologies into complete communications systems.

Now, suddenly, their hour had struck.

At the peak in 2000, these two operations would employ 26,000 locally and account for nearly 40 per cent of the city’s high-tech workforce.

JDS Fitel was what investment bankers called a “pure play.” Its business — unlike that of the more diversified Nortel — was concentrated almost entirely on fibre-optic products.

As sales of such gear soared, as investors realized fibre-optics lay at the heart of the burgeoning Internet, JDS Fitel’s share value went parabolic. By March 2000, the company’s share price was 220 times richer than four years earlier — a two hundred and twenty “bagger” in investment parlance.

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Nortel’s share price over the same period jumped a comparatively modest 14 times while the main TSX index merely doubled in value. The tech-heavy Nasdaq composite quadrupled and bellwether tech giant Apple saw its share price climb 4.5 times.

JDS Fitel’s rise was so rapid it made the company’s top executives uncomfortable.

“We were a quiet little company and we wanted to keep it that way,” Straus told The Citizen in 2001, “Frankly, we had no idea where we were going when we went public. If we had known, we probably would have never gone public.”

The founders — who also included William Sinclair, Gary Duck, and Philip Garel-Jones — were self-effacing academics who had joined Bell-Northern Research in the 1970s. They were quiet Canadians.

Straus and his colleagues at BNR spent their days out of public view, tending to R&D in their Carling Avenue labs. They attended scientific conferences with a global community of physics nerds.

Straus, Sinclair, Duck and Garel-Jones launched JDS Fitel in 1981 “with a few thousand dollars of our savings” according to Straus. The move followed a decision by Northern Telecom and BNR to license the production of certain fibre-optic components to the scientists who developed them, rather than build them in-house.

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It was not then seen as a route to easy money. While the science of light was promising, the associated economics was not. It would take many years before communications networks filled with sufficient digital traffic to justify the installation of expensive fibre-optic technology. Nortel’s fibre-optics business lost money for 40 straight quarters until the late 1990s.

JDS Fitel’s founders were careful with their money. They bought second-hand furniture and rented office space in less trendy parts of town. The company squeezed out a small profit in its first year.

From that modest beginning, the company patiently built a network of customers. Their work was satisfying. They had no desire for publicity or super wealth.

After the initial share offering in 1996, only Straus developed a public profile, an unavoidable consequence of listing the firm on the TSX. But the wealth, that was something else.

None of them saw it coming, not on such a scale.

We know this because the founders had been convinced by the underwriters of the share offering to collectively make available two million of their privately held shares for public trading. That represented 43 per cent of their personal holdings and helped increase the liquidity of JDS Fitel’s public stock.

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When the company began trading in March on the TSX, the founders reaped C$24 million in cash in exchange for their shares. Even after deducting taxes and what they paid for the stock, that seemed a good reward for their efforts in building a profitable company.

Yet, by 2000, those shares were worth more than C$5 billion. The founders had left a fortune in potential profits on the table.

No one felt sorry for them. Nor did they. The founders did extremely well with their remaining shares. But the extraordinary surge in their company’s market value was profoundly disorienting. It seemed like every charitable organization in the country had somehow acquired the founders’ personal contact data. Would-be entrepreneurs implored them for startup capital and valuable minutes of their time. Cabinet ministers wanted to be associated with their success. The founders pondered how to deal with desperate entreaties from city residents with health and budgetary problems.

The example of JDS Fitel rippled through the local economy as word of mouth spread about a magical tech stock that seemed to move in just one direction.

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To sink money into high-tech firms in 1999 you had to suspend disbelief, whether you bought privately held shares in a startup or acquired stock on the open market. Bellwether stocks were extravagantly over-valued in the late 1990s. But they had defied gravity for years.

JDS Fitel had priced its initial offering in 1996 at C$12 per share (pre-splits), giving the company’s 24 million shares a value of nearly C$290 million. That was less than five times the firm’s annual revenues, considered a reasonable ratio, roughly in line with competitors at the time. It was also only slightly more expensive than successful non-tech companies, which tended to be slower growing.

In 2000, though, those JDS Fitel shares would be priced at an astonishing C$58 billion. By then, JDS Fitel was part of a larger entity, JDSU, formed through mergers with Uniphase, E-Tek, SDL and other fibre-optic companies. At the 2000 peak, JDSU’s shares were worth C$190 billion — nearly 40 times the firm’s relatively slim C$5 billion in annualized revenue.

Fibre-optics were also key to Nortel’s sharp rise in shareholder value. In 1996, sales of fibre-optic gear and related broadband technologies accounted for fewer than 12 per cent of Nortel’s total revenues. The broadband unit’s sales sextupled by 2000 when they comprised one-third of the firm’s revenues.

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Nortel’s market value the day of JDS Fitel’s IPO was C$17 billion. At the 2000 peak, it was nearly C$370 billion.

Even from today’s perspective, the scale of the fibre-optic bubble is breathtaking. More so if you adjust for inflation since 2000. This translates to C$600 billion in market capitalization for Nortel in today’s dollars, and nearly C$300 billion for JDSU.

Four short years from Straus’s phone call. That’s all it took.

The crash, when it came, showed us just how fragile were the underpinnings of this shareholder wealth. Tech imploded nearly everywhere but Ottawa’s pain was acute. By the time it was over, the city had reverted to its status as a government town with a tech industry sideline. The big difference: its 100-year champion, Nortel Networks, was gone.

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Telecom Tornado: tales from the frontlines of Canada’s capital is published by Shenandoah Concepts Inc. It is available on Amazon.ca at: https://tinyurl.com/mr35u8px

100 Days: the rush to judgment that killed Nortel is available at: https://tinyurl.com/yv2syzyh

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