Finisar: New Chip-Centric Frame of Mind

While Finisar’s selection of its new CEO, Michael Hurlston, pretty much an outsider from the optical realm (the only exception may be an executive position with Exar much earlier in his career) is not without some risk, fibeReality believes it was a shrewd and audacious choice. While focused on the wireless communications side of the business, he gained a tremendous amount of experience in the same spaces served by optics, including being intimately involved with data centers, service providers, and enterprises – not to mention familiarity with China. Hurlston is also well-known in the investment community. He is in a position to evaluate Finisar’s position in a fresh and objective way, and can potentially find new paths to higher margins, with even possibly the company getting acquired down the road, by demonstrating it does not have to rely solely on those few-and-far-between market aberrations, which lead to product scarcity. While the selection certifies Finisar’s commitment to the 3D-sensor space, as Hurlston has spent his career devoted to semiconductors, it also signifies that the supplier is looking to transition its culture significantly to more of an efficient high volume/low mix production type of firm, and not continue to be trapped to such a large degree in the high development cost/low output model, especially as unprecedented price pressures are making traditional optical componentry operations close to being untenable. Perhaps Hurlston’s most attractive attributes are his experience with mergers and acquisitions along with development of 5G technology.

Of course, picking Hurlston will not change the challenging, physical properties of six-inch VCSEL wafers. However, Finisar’s position in the sensor market should be strengthened by its new CEO being well-acquainted with Apple’s ASIC engineers. Moreover, he will should be able to attract VCSEL bare die talent from the ex-Avago.

Hurlston should be able to effectively communicate to the Street that at a minimum, Lumentum Holdings does not have any intrinsic advantage over Finisar in producing sensor wafers, particularly in the long term, and will likely be convincing that his company has a significant edge, such as with learning curve and with internal control of manufacturing. As the Senior VP and GM of the Mobile Connectivity Products/Wireless Communications and Connectivity Division at Broadcom, he was often tasked with going to investment conferences.

At these events, Hurlston came across as very well-informed with the subject matter, as well as quite articulate, occasionally conveying a sense of humor. He also did not seem to duck hard questions and came across as being honest when it came to market downturns and to unexpected problems with products. Hurlston also seems to effectively preach patience when it comes to the development of solutions.

Turning to M&A, we think that Hurlston may be even more inclined than Jerry Rawls to eventually pull the trigger on an acquisition of Oclaro, partially because of the emphasis on photonic integration at the silicon layer by the smaller competitor. In fact, we think the choice of the new CEO is at least partly an admission that Oclaro has been on the right track – the tough trick is in keeping gross margins relatively high indefinitely. Naturally, greater internal production of componentry within China will continue to be the biggest pressure for consolidation among the largest US firms.

Speaking of China, on the last earnings call, Rawls said that the OEMs would not pick up optical spending until 2019 with 5G, which makes sense given that there would be a potential need for totally new devices, supporting the next-gen wireless infrastructure. While the term, “convergence,” has been overused for decades, it really will apply in the US, with Verizon’s plans to use the complex NG-PON2 solution, targeted principally at enterprise applications, and apparently using the optical line terminals as the wireless BDUs. Despite Finisar’s emphasis on telecom transport gear, but with Hurlston’s deep knowledge of wireless LANs, we would not be shocked to see the supplier acquire an optical chip company, which helps to enable NG-PON2.

As Hurlston is not a traditional insider, there may be a certain amount of internal resistance in what appears to be a dramatic transformation for Finisar. It will be an enormous challenge to pull off, which will almost assuredly involve some painful divestments in order to increase the chances for success. We trust that Rawls will make the management transition as easy as possible, will know in advance that mistakes are almost inevitable, and will continue to give Hurlston his full support.

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]