Clearfield Inc

One on One Interview with, 5G Infrastructure Company, Clearfield CEO Cheri Beranek and Capital Market Laboratories - 'extremely well positioned to be able to take advantage of 5G'

2019-05-02

Author: Tiernan Ray

Written by Tiernan Ray

Edited by Ophir Gottlieb

Lede: Editor's Note
The next generation of wireless network, 5G, is coming -- that is of little doubt. The question now is when, and whom will power it. When it's all said and done, even if it's a decade from now, we're looking at billions of connections working on hundreds of billions of connected devices. Today Tiernan discusses one novel infrastructure company in this space with an one-on-one interview with the CEO.

Story
If you're psyched for 5G cellular, you're going to be waiting a little while. First, there's going to have to be a lot of fiber rolled out - really, a lot.

That's one take-away from a chat with Cheri Beranek, chief executive of scrappy fiber-optic technology maker Clearfield.

Based in Minneapolis, Minnesota, Clearfield, at just 250 people, is nevertheless ready to compete with giants Corning and Comscope to sell outside plant equipment to Verizon, AT&T and anyone else looking to wire up cities and towns of whatever size for 5G.

Ten years ago, the company cut its teeth supplying some of the smaller operators at a time when Corning was fixated solely on selling to Verizon, which was in the middle of building out FiOS.

By focusing on the less-than-gigantic customers, Clearfield developed an intriguing approach to equipment. Rather than being monolithic, its products tend to be modular, letting carriers build out their networks in stages, without a ton of up-front investment, thereby making it more economical for them. Clearfield have also found novel ways to get around some of the cost of labor to install and maintain fiber, another economic plus. Google took note of the company's innovation several years back and used their wares to build its Kansas City Google Fiber installation.

Fast forward, and that novel twist on infrastructure may be useful this time around, because it looks like 5G will be a major building project for years and years before the carriers actually have large numbers of 5G subscribers. By one statistic, the vast majority of service in the U.S. will still be 4G, or LTE, in five years from now.

Beranek views 5G as a huge opportunity to expand sales of equipment to the big carriers, Verizon, AT&T and CenutryLink. But she is also tempering expectations. It's going to take years to get to full deployment in American cities, and it's going to take until probably next year that equipment sales for 5G are a meaningful boost to the company's revenue.

Clearfield shares have advanced sharply this year, up from about $8 and change in December to a recent $13.97. The shares are up about 15% in the past 12 months.

Q&A

CMLviz: Is this rollout of 5G different from the 3G or 4G in terms of the economics?

Cheri Beranek: Yes, because of the extensiveness the fiber.

CMLviz: Because of the small cell size?

CB: Correct. We need about 25 times more fiber to go from 3G to 4G and then another 16 times more fiber than that, when you get to 5G. And, so, we've calculated that for about one square mile of 5G coverage, we need about eight miles of fiber.

(Editor's note: Freedonia and HKExnews show there has been demand for 325 million fiber kilometers in 2018 -- before 5G has begun.)

(Chart Source: Statista)

CMLviz: And that's way up from 3G and 4G?

CB: Exactly. And so, if we look at this in regard to the amount of fiber in the rings that we had in a 4G network compared to the amount of fiber that we have in the rings of a 5G network, I mean, it looks very significant.

CMLviz: And then you've got the antenna issue…

CB: Yes. If you think back to a year to two years ago, Corning and Verizon made an announcement that Verizon was going to buy a billion dollars' worth of fiber from Corning. And then a couple months later they said they buy 300 million dollars' worth of fiber from Prysmian [equipment provider Prysmian Group, an Italian publicly listed company]. That three-year period is really about these rings. The next stage is now connecting up these antennas. This is where we're going to see the labor.

CMLviz: The access network?

CB: The access part of it, yes.

CMLviz: And that starts now?

CB: Yes, in Minneapolis, with the announcement this week that we were the first [for 5G service]...

CMLviz: Some of your neighbors have 5G!

CB: Well, but you really can't do anything with that service. Basically, it's just around U.S. Bank stadium [in downtown Minneapolis].

CMLviz: So, the entire focus here for you is that they're building out the antenna sites, they're bulking up the fiber loops for the bandwidth, but then there will be new drops that are pure broadband, wired connections?

CB: One of the phrases you hear today is there's very little wireless in wireless! So, then the initiative right now within our market is the convergence between wireline and wireless. And in order to really get to the level of getting gigabit service you find in 5G networks, to provide the latency associated with the concept of autonomous cars, you basically have to have an antenna on every other light pole. And effectively that means you are passing homes and businesses with a physical, wired fiber.

CMLviz: What about point-to-point wireless. Won't that be a big part of perhaps both backhaul and the drop?

CB: There'll be a limited level of microwave, but in order to aggregate all of that bandwidth requirement, that has to be fiber fed. Today's 4G networks, 90% to 95% of the 4G antennas are fiber-fed.

So, we're really at the beginning stages, and if we look at it from a timeline standpoint, we call it that the trunk in front of the elephant. This is the timeline that we see 5G services being offered [gestures to chart.]

CMLviz: The knee of the curve is in 2034!

CB: Yes, and out here in 2023, the amount of 5G subscribers is still very limited, in that most of what we're going to see over the course of the next five years is still 4G service.

(Editor's note: According to GSMA, the numberof 5G connections will reach over 1 billion bythe year 2025.)

(Chart Source: Statista)

CMLviz: So, for your purposes, do you have a pretty solid sense of when let's say a meaningful number of metros will be wired using presumably a lot of your product and someone else's?

CB: You know, we had $78 million worth of business last year, and we're forecasting about 12% to 15% growth this year. Which I think tells you that we don't see a lot of 5G action in fiscal year 2019. 2020 is, I think, when we're going to see the momentum.

CMLviz: So, if the orders and the work happen next year, does it go into some kind of steady state of growth starting in 2020?

CB: I think that'll be somewhat labor dependent. And you have to look at the fact that Verizon and AT&T have been relatively stable cap ex investors, right? They're not going to spend, I don't think, a lot more money than they're doing now, they're just going to reallocate where they're spending their money. And so that partially gates it. And then there has to be a level of realism as to how much fiber can be produced. After the [DotCom] crash, Corning shut down a number of fiber plants across the world. And so, we're still not at the capacity that we were at that point in time.

CMLviz: So, if everyone bought a 5G phone, it sounds like there wouldn't really be enough network capacity any time soon to support all of that usage. Do we know how fast that shifts into broadly available?

CB: It's been a big debate, and nobody has the answer as to when that will actually happen. There have been some really aggressive timelines thrown out there. We were at this cellular conference this week ["Creating the Foundation of 5G an IoT," April 11th in New York, hosted by Prysmian], and there was this gentleman speaking who was formerly with AT&T and is now a consultant, and he was saying two, three, at most five years - and the whole room was, like, In your dreams, man!

CMLviz: I understand that the economics and the structure of this many sites and these many drops is different, but is the uncertainty about the pace of that infrastructure buildout different this time around than it was with 3G and 4G, or is this what you've seen each time you've seen this?

CB: 4G was easier because all you had to do is upgrade the macro site. Big towers, large areas, with fiber, and then it could handle the 4G traffic. This is different. And then permitting and right of way become the biggest obstacle. We were talking Telus yesterday, who has been deploying fiber to the home in Canada. And they or their engineer said it's not that permitting takes too long. Is that permitting isn't it you can't plan it, that there's, you know, communities aren't good at setting expectations. And then, it's one thing to get right away and put an antenna on your own light pole if you're the municipality. And it's a whole different thing if carriers want them to be on a building, then you'd have to be able to talk to the building owner. And again, because of this line of sight issue, there's a lot more restrictions in regard to where that's going to physically be placed.

CMLviz: So, it's not different qualitatively, philosophically from other periods, but there are enough technical factors that there's greater uncertainty about the uncertainty! So then if this is the situation, when you talk to the street you're not spending a lot of time telling them you know 5G is just going to rock it for us…

CB: I mean I'm trying to start to set expectations in that we're extremely well positioned to be able to take advantage of it, but we're not driving 5G. We're going, we're there to be able to provide the connected, the fiber management protection and connectivity that's going to enable it. I am.

And I think our ability to provide you know the customer configuration and the fact that we can scale those are options for us as to why we're now being able to sit across the table to these very large providers and looking at ways that we can put things together. One of the factors that will accelerate 5G deployment is that they need to monetize the 5G networks and get some return on that investment. So, while there's gating factors that could slow it down, there's also the business factors that could accelerate it.

CMLviz: What's your status with Verizon and the other Tier 1s?

CB: About 10 percent of our business today it is to these large Tier 1 customers. And we're aggressively investing to be able to be a more dominant provider to them. We sell to Verizon, AT&T and CenturyLink as Tier 1 providers, and we provide a limited level of product today to all three of those customers. It's a huge opportunity for us.

We've had to make investments to sell there, to get Telcordia certification. In order to sell into Verizon, in order to sell into AT&T, those are long, involved testing processes to make sure that the connectors and enclosures that you're using meet their requirements. So now when we sit across the table from Verizon or AT&T, it's not like we are an unproven commodity. We have nearly 25 million ports deployed across the country we have 800 customers. We have salespeople across the country, in Canada, Mexico, the Caribbean. And that's part of the high-touch model, because we feel that we've got to be able to be in the time zone to be able to continue to provide the level of service that we started with.

CMLviz: So, what's your pitch vis-a-vis Corning and Prysmiam?

CB: Our objective is in order to really make fiber to the home and 5G possible is to make things more craft friendly.

When you're laying that amount of fiber, now labor becomes even more critical. Because outside of the [wireless] spectrum cost, the biggest cost associated with deployment is not cap-ex, it's the labor. And so, we've got to be able to reduce that. We can't look for a handout from the government to be able to fund 5G. We've got to be able look at ways to reduce the cost of deployment, and the best way to do that is to attack the highest cost structure, which is labor.

Corning's got some great engineers and great scientists, but our orientation is let's not do things in a lab, let's do things in the field where the craft people are the ones who are going to have to make a difference. And if we're going to be able to do things in this marketplace, with such low unemployment, we've got to be able to keep the skilled splicers at the transport layer, where 5G is being laid, where they've got high fiber counts, where splicing makes sense.

But when you're in the access network and you're connecting that home or business, you need to take a skill out of that, to make it craft-friendly and allow a new labor market to be put in place. If we can take that skill out of the deployment, then we can accelerate 5G, and be able to move forward.

CMLviz: How does that translate into different equipment?

[Clearfield's COO Johnny Hill, whose business card carries the amusing motto "dances with light," steps into the conversation to explain the company's fiber product.]

Johnny Hill: We have this device that has ports on it, what we call "FLEX port." You bring your micro-duct, after you buried it, to a FLEX port, and then you just plug it in. There's no special tools required, no real skill to speak of. And so, you're able to, once that pathway is established, to push it up to 300 feet - sometimes farther, but 300 is safe. The average drop length in the U.S. is about 150 to 200 feet.

And so, you push it back in, and once it comes out the other side, you assemble it into an industry standard interface, what we call a SC connector. That plugs into the termination equipment in the home. And that's all done without any special tools, without higher skilled labor that is rolled to, for example, splice-on a connector.

CB: The second advantage associated with that product line is that they say once every seven years a line in your yard for telco services or broadband services is going to be cut, whether that's copper or fiber. If it's a direct-buried product from one of our competitors, you've got to dig up and replace the whole thing.

If you have a Clearfield product using Field Shield, because of the fact that it's a drop cable pushed within a microduct, you simply locate the cut, dig up about six inches around the break, pull out the fiber, push in a new one within the established microduct. Using what's called a "coupler" – you rejoin the microduct back together, and in one track roll, in about an hour, you've restored service. We've done studies with telephone companies who have indicated that over that seven-year lifetime of our product, the total cost of ownership for this type of deployment is about 50 percent less than the direct-buried product.

We also have acquired our first product line, which is an active cabinet. That allows us to be able to extend our presence. And it's part of our 5G play. There's different parts of different tiers, or different rounds of the 5G initiative. And one of the things that we see coming is a need for an universal active cabinet that can be used in a variety of ways, with a variety of electronics. But there is a need for it to be carefully monitored because of the heat to those electronics.

JH: Also, they're still defining where all this infrastructure is going to go. They're [the carriers] trying to hide it because they know the public's not going to like these things being all over the place.

CB: Right. Traditionally, for example, what's called a fiber distribution hub is set on the ground, on top of some cement that's on top of a vault. A few years ago, we designed a below-grade [underground] vault we call "Makwa." It's a below-grade fiber distribution hub, which is completely buried, so that if you've got a permitting issue because the community doesn't want anything ugly or an eyesore, now we can put the same kind of device below-grade. And without significant cost penalty.

Makwa means "bear" in Ojibwe [a dominant Native American tribe in the upper Minnesota region.] We named it Makwa because it was equally comfortable aerial-mounted or pole-mounted or pad-mounted or below-grade.

CMLviz: What's the largest metro that you can help build out?

CB: It doesn't matter. We started with a small cell phone companies, but then went to the large. The product line works in any of those situations.

CMLviz: So, if they wanted to wire New York, you could help?

CB: Yes.

CMLviz: Given all that, what are the priorities for your company this year?

CB: Well my job is always to be able to provide scalable growth for the organization. And you know we've focused the organization for the last ten years on profitable, sustainable growth. And for the majority of our you know our lifespan, you know as a company, we grew at a compound annual growth rate of about 15 percent. A couple of years ago we kind of hit this stable $78 million level [of revenue], and which appears on the outside that we've stalled.

But really what we've done is we've reinvested the dollars into new markets and new opportunities so that we can take this next big position for the next layer of growth. We really, we have what we call a coming-of-age plan, which is a three-year plan to take us to 2021. And there are three pillars of our coming of age plan. The first is to enhance our community broadband position, our core. The community broadband is today about 70 percent of our business. It's those tier 3 providers the municipalities the utilities and by protecting and enhancing that core. That's where we really get that craft friendly knowledge because we're working alongside that organization.

The second pillar of our coming of age plan is to enhance our competitiveness. We understand at this point and especially as we go into larger carriers that we're going to that we're going to see some price pressures that we haven't seen previously. And so, we're working on enhancing our manufacturing abilities, you know, our ability to have a broader number of suppliers, and really to position ourselves for long term profitable growth.

And then the third pillar is putting ourselves in a position for disruptive growth, and 5G is that disruptive growth opportunity. And we've invested this year a significant amount of SG&A spend in certifications and in salespeople. So that we can be in front of those decision makers, you know, before it's deployed, and then take advantage of it you know in 2021 and beyond.

CMLviz: When you say disruptive what you mean is to come into what Corning or some means might. And, to displace them as the supplier?

CB: Correct. Because we know that when we go into these large providers [telcos], that a primary and then a secondary source is the way they manage their risk tolerance. And so, we don't need to be the primary supplier in order for us to be to grow significantly moving forward - although I'll go for first!

CMLviz: But when you are looking to displace the incumbent supplier, who can use pricing power, they can take the hit on margin to put pressure on you with price….

CB: Right. If I'm only going to play on price, I can't take Corning or Comscope out. I have to be able to provide a craft-framing orientation that allows them [carriers] to reduce the labor cost. So, somebody looks at total cost of ownership, I can absolutely be competitive in providing that alternative.

CMLviz: Is there still some effect upon margin for you, though?

CB: Yes, our forecast for this year is that our gross margin is going to take a couple-point hit. But long term we believe we can get back to what we think was really some world-class situations where we were at 8% to 12% net income. And I don't have a forecast as to when we're going to be there, but we do believe that type of profitability is possible for our organization.

CMLviz: Cheri, I know you're a big believer in STEM education, especially for girls.

CB: It's a passion of mine. I have four kids, two girls and two boys. Three of the four are in science-related environments. What I like about women in STEM is the fact that very early on in your career, it's difficult to rise to the next opportunity if it's really qualitative in your [employment] review, if having additional opportunities is really a qualitative or subjective program.

But if you are in a STEM career, it tends to be much more quantitative. And the opportunity for measurement makes it possible to advance and to create different options. And as a result, I think that if we can promote STEM, to allow girls to think of themselves as scientists, and to like science when they're 10 years old, then they'll have the opportunity for advancement opportunities later in life. So, I think STEM shouldn't be thought of as a college initiative. It should be thought of as an elementary school initiative, and allowing those girls to be able to think like scientists.

Neither Tiernan nor Ophir have a position in Clearfield Inc (CLFD) at the time of this writing.

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