Lumentum and the Problem with Hubris

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At least up until recently with the China boom, which has subsided for now, the extraordinary challenges in being an optical transceiver supplier have become manifold over the last 15+ years, including poor margins, direct competition from large customers, and a high level of market fragmentation. Such conditions would hopefully lead to a greater amount of introspection on the part of the leadership at these corporations, which would prevent getting carried away with excessive rhetoric or specific projections on performance with new opportunities. While Lumentum Holdings will clearly dominate the 3D-sensing space with its shipments to Apple for the latest generation of its iPhone this year, it would be very surprising that even if 50%+ gross margins are initially achievable, their sustainability in the very short term, appears to be highly unlikely.

As we pointed out about a week ago to followers of our LinkedIn fibeReality blog, Apple is notoriously ruthless in getting the price of external components down to the bare bones, particularly on the iPhone. Another expected cause of less profitability is the potential for at least three other VCSEL players entering the fray.

In addition, there is precedent for Apple changing contracts with suppliers in a quarter to reduce prices. Reportedly, “Apple got suppliers to slash the fees they charge for the iPhone 7 range by 10%-20%.”

The tremendous amount of exuberance by Lumentum may partially be explained by its freedom of being under the thumb of the testing division at the ex-JDSU. In contrast, Viavi Solutions, despite expectations of being a major beneficiary of the iPhone moving in this new direction, has been rather conservative and limited in characterizing its prospects.

Nevertheless, the last thing that a supplier wants to do is essentially throw in Apple’s face how much money it expects to make on componentry for the iPhone. It is not exactly a secret that the cost of producing the iPhone has gone up, and so, it is hardly out of the question that Apple will be inclined to penalize Lumentum for being so vociferous. Hence, the pressure on the vendor to diversify with other smartphone vendors may be greater than with the other 3D-sensing suppliers.

One should also take note that with this market, evidently about VCSEL dies, the lack of current discussion in the industry about Broadcom (Avago) entering the space, which at least in the past, the company was a dominant supplier of such devices for computer mice. With that large chip vendor appearing to stay out, it seems to demonstrate a lack of confidence in sufficient margin potential by the firm.

Even more potentially ominous for all of these 3D-sensing vendors is that Apple is hastening its efforts to stop buying external chips for the iPhone, and take more advantage of internally developed technology to achieve the lowest cost, while obtaining the greatest level of quality, and to better ensure various strategic advantages.

[written by Mark Lutkowitz]