Lumentum 3DS at Apple: A Competitive Analysis

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Right now, it seems that Lumentum’s primary challengers for VCSELs for 3D Sensing (3DS) applications for use in Apple’s iPhones will probably remain both Finisar and II-VI indefinitely. We strongly suspect that this large customer is champing at the bit to have some real volume coming from another vendor other than Lumentum in order to have greater price competition. Also, Apple is undoubtedly still looking forward to being in a position to punish its largest supplier for what can only be described as poor judgement in being so vocal originally about its projected margins at a time when there was really only one buyer. fiberReality also believes it has become clearer as to a major reason Lumentum has not raved about the extraordinary accomplishment of delivering six-inch VCSEL wafers, perhaps along with arguably its premature messaging shift to edge emitters. It appears that its external team of supporting manufacturers was almost totally responsible for bailing Lumentum out just in the nick of time on the initial large order. In evaluating the competitive landscape moving forward for these VCSELs, it must be done in the context of the overall strategic direction of these three principal players as well as their broader strengths and weaknesses.

We have addressed in the past our judgement that Lumentum’s top management has demonstrated a lack of adequate maturity in four significant ways, including: 1) its evident willingness to abandon some of the important chip development by Oclaro, which would otherwise be very helpful in supporting its traditional business, while transferring that capacity to its 3D sensing business that will increasingly face huge margin pressures; 2) its fixation on the higher end portion of its telecom product line, which will have it sometimes in a situation of competing head-to-head with its customers; 3) its lack of frankness (at least initially) on the pace of product development, such as with CWDM4 and 400G; and 4) its apparent obsession with one-upmanship relating to its former partner at JDSU, Viavi Solutions. Another revealing aspect was pointed out to us by an investment analyst in that it is quite unusual for a CFO to be leaving in the middle of a major acquisition.

Nevertheless, Lumentum is clearly the worldwide leader in the 3D-sensing space, and it therefore has a major competitive advantage at the moment over other companies in going after business from additional smartphone providers. It deserves a tremendous amount of credit in anticipating the paradigm shift away from large production of VCSELs by non-traditional foundries. While farming out the production will further eat into Lumentum’s margins, at least it does not have the headaches of the other two competitors in dealing with the overhead.

Regarding Finisar taking on Lumentum in a bigger way, the former is in a position of strength in that Apple definitely wants to have a domestic supplier, which is vertically integrated. Also, Finisar will continue to benefit by the major (and rather unusual for Apple) PR dog and pony show, which while disingenuous on the exact details, was evidently a demonstration of quite a long-term commitment to the vendor.

On the other hand, it is a very different business model for Finisar to be in a high-volume chip manufacturing business. It also does not help that Finisar’s new CEO ironically comes from Broadcom’s vRAN side of the business, where at least when it came to ICs, it was based on a fully outsourced model. Constructing a fab, and dealing with that level of investment in place is obviously not an area of competency for him. At the same time, he has to also juggle a major renovation of the data communications segment within the corporation. Given the new stress on profitability over revenue, we would not be surprised to see Finisar either divest this fab or convert it for other types of solutions in the very long term.

Concerning II-VI, it has the most flexibility compared with the two other firms in that its other businesses are performing quite nicely. In fact, it is noteworthy that although we recommended that Finisar strongly consider getting into the traditional VCSEL bare die business, II-VI’s recent results in the datacom space for these devices are rather impressive.

From the beginning, we had questions as to II-VI having the necessary fire in the belly to totally commit to VCSEL wafers aimed at 3DS. If the firm winds up in the third position at Apple, it could easily have a hard time remaining competitive in the VCSEL die space, just because of the volume and infrastructure requirements. II-VI would definitely need to find other opportunities for sales with other customers in order to stay viable in that market.

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]

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