Infinera: Doubling Down on Lost Cause

After bringing in an executive, who promotes to companies he will “lead a transformational charge to growth, profitability and long-term value,” in our opinion, the last earnings call at Infinera was in general just more of the same strategy, only the messaging was more convoluted than ever. While it would be very difficult at this point to figure out a way to put the vendor on a healthier path, just being confined to the literal, cosmetic, and superficial goal of “enhancing internal alignment between our engineering, product management, and marketing teams, and ensuring efficiency in our overall development process” is barely sufficient. If Infinera has any chance for survival, it needs to drastically cut back to a minimum number of products, which have the best chance for success, and give up considerably on its planned aggressive R&D expenditures. Last November, it is quite probable that we gave the CEO, Tom Fallon, way too much credit for “be[ing] open to radical changes,” which is absolutely necessary. In addition, Ciena’s move to provide a detailed three-year outlook on its expected performance, evidently compelled Infinera to at least attempt to provide insight into the full year, which we believe backfired on the struggling supplier. Moreover, if it turns out there is not a substantial amount of business from CenturyLink-Level 3 going forward, it would have a devastating impact on the optical system house.

fibeReality would not be surprised if Infinera’s Senior Vice President and General Manager, David Heard, who came aboard in June, had advocated a plan, which substantially would have taken the company away from what we would characterize as throwing an assortment of solutions against the wall, and seeing which ones will stick, to one that would ultimately be closer to a barebones outfit, which could potentially survive indefinitely. It appears very possible now that Fallon would not have been able to accept such a dramatic alteration of the firm.

Continuing with this hypothesis, Fallon would have had no other choice but to bring back ex-President, Dave Welch, into the fold, as he may be the only optics engineer on the planet, who stills fully believes in the utility of Infinera’s PICs. Irrespective of the actual events, the future of a public company should certainly not be based on the occurrence of a miracle.

After listening to Infinera’s last earnings call, it is hard for us to remember a company’s presentation that we found to be filled with so much obfuscation, incoherence as well as overly lengthy explanations. If there was truly a light at the end of the tunnel, the narrative could have been stated very simply and concisely.

The worst aspect involved the future of the entire product line, which had the appearance of a hodgepodge in making changes on the fly, based mainly on bringing in the most revenue in the short term, rather than a comprehensive plan to deal with overlap between platforms. The limited prescription of a greater amount of elegance being required came off as shallow.

On the one hand, Infinera tried to assert there is not a “product proliferation problem.” On the other, “we’re converging and killing some products that don’t offer a differentiated value.” Such confusion will not provide a high level of confidence to potential customers with a roadmap in such a state of flux.

Infinera also talked about aggressive trialing of its new solutions, but such activities are no guarantee of future business. As we have noted in the past, the real selling occurs even after the contracts themselves are signed.

Moreover, while “cable operators’ Fiber-Deep strategies represent a major incremental revenue opportunity,” as Infinera indicates, other vendors will be going after this business as well, including Arris, by far the dominant optical transport equipment vendor in the MSO space. Naturally Arris will be a formidable competitor as well with Remote PHY, and if Infinera’s plan “to foster some partnerships with some of the more traditional cable equipment providers who have not really historically solutioned around DWDM and transmission” involves an OEM arrangement, it would obviously eat into its margins. Regardless, given the vendor’s present hardships, it would be reasonable to assume that a partner providing access to the sector would be in a position to demand a significant piece of the action.

Turning to the Open ICE concept, it is one thing for a medium-sized optical system vendor to sell transponders, it is an act of desperation to make it a leading portion of one’s marketing game plan. We have been outspoken about our belief that there is no evidence that Infinera’s PIC technology provides any cost advantage, and any edge that comes with “higher capacities…lead[ing] to a lower cost per bit” would apply equally to all existing competitors.

Regarding ICE5, we have expressed our opinion we would not necessarily expect it to see the light of day. Nevertheless, when Infinera talks about the next-generation “optical engines remain[ing] on track, when does the two-year clock begin? Is it after the final ICE4 products becomes entirely available? When would another “low point on gross margins” begin?

On the projected outlook for the full year, Infinera initially tries to express something resembling confidence in a higher margin for the entire year, but then almost immediately has to pull back, hedging with qualifications. At best, such a result would put it in the same expected ballpark as Ciena anyway, which like every other player in the market, has not felt the need to resort to PICs.

Once again, the only time Infinera was in the 50 percent range on gross margins was right around the acquisition of Transmode, which inherently had the advantage of going after sales in which the competition was less fierce. On the previous earnings call, we thought that Fallon finally realized the full benefits of the XTM. Now it is Welch seemingly trying to progress with his fixation of messing with the technology as much as possible in talking about “continued further integration of the XTM product line.”

Finally, although Infinera argues that it can do quite well without substantial sales from CenturyLink even for a little while, how can it say it is a leading optical equipment supplier with relatively little to no business from any of the three largest incumbent ISPs in a country, which protects domestic vendors from Chinese competitors?

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]