Ever since the last optical boom in China, it has been easy to be NeoPhotonics concerning limitations for growth in its traditional space with much of it based on a disproportionate amount of overexposure to that country’s marketplace, on the very low prospect of getting acquired (especially at any kind of a premium), and on the lack of a comprehensive diversification strategy. (NeoPhotonics did very briefly bring up “adjacent markets” during its last earnings call.) While all of these factors are clearly related to each other, it is the third one that could provide the supplier with the biggest competitive advantage in the long term. In the short term, fibeReality anticipates that NeoPhotonics will likely be one of only a few US optics companies to substantially benefit from the revival of ZTE, a recovery by the large customer, which this (see the comments section) would happen much sooner than the conventional wisdom. While there is surely starting to be a pickup as well at Huawei and at least one other significant Chinese system vendor, including for ROADM types of devices, particularly now with ZTE out of the US penalty box, which is bringing business to both Lumentum and Finisar, the movement toward increasingly using local, Chinese sources for optics componentry (and/or Huawei greater vertical integration) continues forward. In addition, the last major pent-up demand was based on a substantial need for long-haul gear, while this time, there is a greater emphasis on metro equipment, which always takes longer to deploy in any part of the world. Moreover, while the development of 5G will keep on having vital national security implications for both the US and China, we suspect that Chinese service providers will be more inclined to be followers of Verizon, as the enormous complexity in making the business case work will in the industry. Altogether, with the implications of tariffs, which fibeReality foresees as mainly bargaining chips for the US in terms of the country striving to gain both economic and security leverage over China, we imagine a mini-boom at best this time for American optical piece-part companies, as well as a any insane rhetoric from both investors and vendors about a market super-cycle.
Assuming that there is sufficient capital offered by the hyperscale operators to ensure adequate technical development to provide the necessary high-end products for its internal networks, NeoPhotonics, remaining focussed at the very top end (in combination in pretty much market with its ultra-narrow linewidth lasers) could turn out to be a sleeper. An important supposition is that these customers that driving down prices to close-to-unprofitable levels, if not worse, would only result in the requirement of further outlays of cash by them to ensure the next generations of capacity. However, such a transformation in mentality is hardly a certainty, especially when it comes to all of the big four hyperscalers, which, as always, move the needle in the data center space.
Although another expected winner of the ZTE comeback is Oclaro, we wonder whether joint development efforts between the supplier and Google, including on an OSFP to get to 800G, would be as much of after the merger is completed with Lumentum. There is also uncertainty as to where exactly Finisar its efforts in the foreseeable future. Both suppliers may be understandably resistant to playing in a space in which 100G CWDM4 could easily stick around as the dominant solution over a lengthy period because of the sheer technical obstacles in the way of 400GbE+ hardware.
Thus, NeoPhotonics may turn out to be the only relatively large US transceiver company almost totally devoted to the higher data rates, most notably on the customer premises side, while also having of staunchly supporting the ecosystem before it was destroyed. The firm may be able to keep those large buyers honest on price when it comes to 400G and higher rates, at least for a while, based on a simple situation of supply and demand. So, it is possible that a patient path ahead will ultimately help get the company into a healthier position, and then hopefully facilitate a more appealing exit through an acquisition – probably way down the road.
As always, fibeReality does not recommend any securities, and this writer does not invest in any companies being analyzed by us.
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[written by Mark Lutkowitz]