At OFC 2019, Lumentum Holdings finally acknowledged the principal rationale for purchasing Oclaro, by announcing the divestiture of the data communications transceiver (TX) product line of the latter (last September, it was certainly clear to fibeReality that such “Oclaro” equipment was going a hit), and by stating in extremely direct terms Investor Session, the destructive pricing environment at the hyperscale data center operators (this overall motivation for the buyout a year ago, referring to an ecosystem collapse). Incredibly, as recently as late, last month ( Morgan Stanley Technology, Media & Telecom Conference), Lumentum asserted that at the time of the announcement of the buyout: “We didn’t know how bad or how challenging the [the data communications transceiver market] would be.”
In fibeReality’s opinion, Lumentum also figured it could not afford any short-term perception by analysts on the Street that the deal, which included a handsome premium, was just for a competitor to be taken out. At the time of the purchase, close to half of Oclaro’s sales at its latest quarterly announcement were for client-side products.
So, the “long-term” agreement with CIG Shanghai to supply photonic chips has to be viewed at least partially as an attempt to give the firm some cover on such a negative conclusion. While fibeReality can hardly blame the supplier for “moving downstream,” as we agree there can be much greater differentiation with far less competition, there is still the great challenge of ensuring sufficient volumes to keep costs in line.
Also, that Lumentum is “taking [a]…page from the [Avago] playbook” is clearly false. The company that became part of Broadcom divested its entire transceiver (TX) business, while Lumentum (although scaling back on any new R&D efforts) is still holding onto its legacy module products. Furthermore, Avago evidently received a nice premium on the transaction, which given the matter of timing, would be expected to be quite difficult to come close to matching in this case.
Lumentum was never challenged during the “Session” on why it would want to still retain these devices, with no timeframe volunteered to end their life, which are as difficult to generate margins, as the sold-off Oclaro assets. We strongly suspect its partial strategy of engaging in a push/pull approach with the hyperscalers, regarding its chips, by itself, would have been inadequate.
Given the anticipated level of on the technical side by these cloud players, including to funding infusions from them, that the total elimination of a second large, domestic, well-established provider of these TX modules would just not sit well with these customers. Of course, even both Intel and Cisco Systems have felt forced such loss-leaders, which are outside of their core businesses.
We also have heard that Lumentum is counting on a marked increase in sales of 100G datacom TXs to hyperscalers based in China, and may not want to be in a position to justify having to miss out on such a big opportunity. Conceivably, they could temporarily result in higher margins (assuming there are no significant trade issues involving the US government).
Lastly, it was a positive sign that Lumentum finally came to the commonsense realization that having a true CFO in-house comes in handy with any kind of M&A activity. We wonder if the “many interviews” of Wajid Ali were necessary to ensure the top-leadership an adequate comfort level of keeping resistance of the company direction to a minimum.
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]