While the CEO of Finisar has been associated with the company for over 25 years, the average time that the rest of the executive management team has been in the optical components space is around 18 years. Undoubtedly, they have to understand how terribly unique their situation has become after years of mounting obstacles that have made its business quite unattractive in the recent past. The combination of the Street inexplicably driving up the valuation of a single company, Acacia Communications, to extremely unjustified levels, which positively affected other vendors in the market, along with the exploding demand for componentry in only one country, China, could not have been anticipated. It could be said with a high level of confidence that such a confluence of events will never happen again. Although we believe that Finisar still has room to somewhat improve its financial position in the market, it should look to exit right away while on the way up, as opposed to taking the risk that conditions in the market will remain favorable indefinitely. Most importantly, whenever things get back to normal, does it really want to be stuck again in an ever-worsening space to generate margins?
The biggest reason for Finisar’s short window of opportunity is our continuing belief based on intelligence gathering that Huawei Technologies intends to enter the optical components business. In fact, it would be hard to imagine why the Chinese vendor would just stand by and not look to get a piece of this action, particularly in its own country. The other advantage would be in potentially making substantial penetration into the US data center interconnect business, which will increasingly be moving in the direction of open line systems and white boxes. Even if the lunacy of a 5% or 10% tariff were to happen in the States for all imported products, Huawei would probably still be willing to substantially undercut competitors sufficiently to make it an attractive alternative.
Another compelling justification for Finisar exiting is the heavy reliance of its future growth being dependent on purchases in China. Although there is a lot of investment being planned on infrastructure in general, the country is being burdened with bigger amounts of debt reaching about 300 percent of its GDP as well as with asset bubbles threatening to burst.
With Finisar’s relatively high valuation, the only companies that may be interested in an acquisition might be only contract manufacturers or private equity firms. Alternatively, the vendor could divest its assets through a combination of sales of smaller portions of its business, possibly along with spinoffs.
One way that Finisar is playing hardball with its competitors, and is also resulting in a possibly higher value for the company across the board, is by openly discussing aggressive manufacturing capacity build-outs. It acts as a preemptive strike in making other players think twice about further additions in their own facilities for fear of creating an overcapacity problem in the marketplace. (Finisar may also be showcasing its VCSEL business for sale discussing adjacent market applications beyond usage in data centers – although we would have our doubts on any kind of tremendous growth levels with such future apps.)
The $500 million from a convertible notes issue could be used at least partially for expansion of production capacity as well as other items to help Finsar sell off its business. However, if some of the speculation is correct, and it is a means of acquiring Oclaro or other smaller players then it will be certain that Finisar is committed to remaining in the market for the very long term, a result that the company may easily regret down the road. Of course, if Huawei truly does enter the space, there may be a whole lot of consolidation taking place.
Please consider our latest reports, Clash of Metro 100G Optical Vendors with Shifting Network Paradigm and Clash of Optical Component Vendors & Technologies in Data Center Networks. For more frequent updates, please click here.
[written by Mark Lutkowitz]
Given the fact that Huawei entered the optical components business roughly ten years ago, I’m bewildered by the following statement:
“The biggest reason for Finisar’s short window of opportunity is our continuing belief based on intelligence gathering that Huawei Technologies intends to enter the optical components business.”
There is a difference between being a “system” supplier and a “components” supplier.
Larry, I hope you’ll excuse me for being a bit more verbose than I planned, and accept the following as a respectful and constructive response.
Huawei has been building transceiver modules for so long it’s simply not a newsworthy topic. Due to that, it’s not something that would come up on a conference call unless an analyst asked a specific question, and since it’s common knowledge, I don’t recall the question coming up. However, I’m sure you could ask the CEO of any optical components company selling to Huawei for confirmation, and with that, maybe get some more color. If you have a line of communication with Jerry Rawls from Finisar, I’m sure he would discuss it candidly. You could probably also search Alibaba and find Huawei transceiver modules for sale there.
I’m not sure what you are trying to communicate in the following sentence:
“We are aware that Huawei set up a passive group for components in the past. In general, it works with other Chinese vendors as well as internally develops components.”
Is this intended to acknowledge that Huawei has developed optical components in the past, or is it a reference to passive versus active optical components? Huawei manufactures both.
Heck, let’s be specific and clear; do you expect Huawei to develop its own WSS or coherent transceivers and sell them in the merchant markets? Do you expect Huawei to develop its own pump lasers or channel monitors? I don’t see what Huawei is manufacturing today as negatively impacting Finisar, but if Huawei develops and qualifies its own WSS it would be negative.
What we’re seeing in fiber optic components is not the “super-cycle” that so many analysts are broadcasting; it’s more a trend shift coupled with a strong cycle. Within the trend shift we’re seeing broad deployment plans for ROADM within China (trials started last fall with FiberHome and China Telecom) where there is near or literally zero ROADM deployment in domestic networks. To the best of my knowledge, Huawei (ZTE and FiberHome too) buy the core components needed to build ROADM line cards.
In western markets we’re seeing ROADM deployment spread from the core where it is well established, into the metro where there is minimal ROADM deployment today. Finisar sells the various components it takes to build a ROADM (the WSS is the most important) as well as complete ROADM line cards. An upside to Finisar’s current status in western markets would be WSS qualification at Cisco, which has been an ongoing process for quite a while.
Also in the trend shift is a move to coherent transceivers, which radically reduces the number of potential competitors. To the best of my knowledge, Huawei does not build coherent transceivers.
In addition to these trends, there is a broader trend of connections moving from copper to fiber – these include relatively short links and even board mounted fiber optics. In response to these trends, the strong cycle, and I suspect, a planned acquisition, Finisar is erecting a third building in Wuxi that will increase its capacity there by 50%.
The VCSEL trend is kind of a bonus in that it addresses an entirely new market that is not at all related to traditional point to point communications, which has been the primary driver for VCSEL since its invention. Here VCSEL is displacing IR technology and enabling new markets.
I’ve been pretty close to the emerging mobile / 3D VCSEL market for several years (more broadly termed as consumer 3D since it extends beyond mobile), and discussed it with Jerry Rawls two or so years ago. I think a NDA from some of my early involvement with another company is still in effect, so what I can say is fairly limited, but the short story is VCSEL arrays will be used in a variety of new consumer applications going forward. Each array should have between 100 and several hundred VCSELs, and some of the applications have the potential to be VERY high volume; much higher than the traditional communications applications.
I believe we’ll see many of flagship smartphones introduced in 2017 use VCSEL arrays for camera focus, and that it will become mainstream within the next couple of years. There are other potential applications beyond focus. Since these are design trend shifts, using historic data, even from adjacent markets, has limited value. BTW, I’m curious what you are referring to as “historical trends regarding profitability with adjacent markets”.
Based on comments made by Finisar executives during its last conference call, I expect gross margins from VCSEL 3D applications to be at or slightly above the corporate average. However, there are several moving pieces in the equation involving yield allocation and economy of scale that should result in higher margins for core communications applications. As a result, I think operating profits for VCSEL will move higher while revenue from VSCEL grows significantly beginning in the second half of 2017.
I don’t think it’s accurate to say Jerry Rawls expressed “reservations” about the potential for VCSEL 3D applications. Below is a statement made by Jerry Rawls during the last conference call that explains why Finisar has and will continue to boost capital spending during the current quarter to increase its VCSEL capacity:
“3D sensing is something that we’ve been working on for years. We have had a number of smaller customers, and it really hasn’t moved the needle much in terms of revenue. But over the last year, maybe 18 months, discussions in a number of consumer-based industries have really heated up, and as a result, we think that there is likely to be significant revenue and upside for us next calendar year, for sure. Now and the reason we talked about it in this conference call was because all of a sudden we’re spending a lot of money on it. And so Kurt thought if we’re going to spend a lot of CapEx, we probably ought to tell people why we’re spending a lot of CapEx.”
Paul,
In terms of more specifics on where we believe Huawei is moving with optical components, click here.
Regarding Huawei already being an optical components vendor, after a fair amount of looking, I did find one reference going back over 11 years ago. However, the very next sentence only talks about service providers — so, the word, components, may be used very broadly. If we are going to talk about Alibaba, with the movement towards open line systems by hyperscale operators, then we can say that Ciena and Nokia Alcatel-Lucent are component vendors as well, but I do not think anybody tends to do so. I have talked to many people about Huawei getting into the optical components business, but you are the first to make an issue of it supposedly already being in the market. I believe in being as exact as possible and I take you at your word that you know for sure that the company has supplied components. Of course, there is a difference between development for vertical integration in the past and actually shipping them to other system houses.
JDSU sold full passive systems to telephone companies, but I do not think that people in the industry ever referred to it as a system vendor. Infinera perhaps shipped a little more than a handful of systems to Verizon, but it is not considered a vendor to that service provider. Google is still supposedly supporting and and building upon a limited number of cities for fiber to the home, but is it still in the FTTH business? All in all, we are beating a dead horse.
At least we agree there is no super cycle.
Regarding VCSELs, I happen to be a fan of the solution, especially for very long-term use in data centers. I hope you are correct in your opinion. I expressed my opinion and chose my words carefully — in terms of “tremendous growth levels.” If Finisar happens to buy Oclaro down the road, the latter will be provide the former with a great deal of intimacy in the potential pitfalls of using such gear in the consumer business. Concerning Finisar’s statement itself — it used the word “likely,” which I understand is mandatory on an earnings call, but there is also talk about “lot of uncertainty” and about a “bet, “tough negotiations,” and no room for product differentiation.
Mark
Mark, After further investigation, I’m convinced your Finisar thesis is wrong and that there are material flaws in your data upon which it is built. Beyond what I’ve already pointed out, I’ll leave it at that for now, but wanted to include this brief comment in the record. Time will square the bottom line.
Regards,
Paul
Paul, Nice little hit and run after being gone for three weeks. Nobody gets everything correct, but I will put my track record of close to 35 years against anyone.