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Does Finisar Corporation Have Any Growth Opportunities?

Tuesday - 3/19/2013, 11:51am  ET

Finisar Corporation is a leading provider of optical subsystems (transmitters, receivers, transceivers, transponders) and components that are used in data communication and telecommunication aapplications.

The demand for these products is mainly driven by growth in demand for bandwidth by enterprises and service providers. The demand for bandwidth is expected to continually grow due to the increasing use of videos, photos and digital information, not to mention various online apps. Over time, carrier spending will increase to provide more bandwidth capacity.

3Q13 results

Finisar's 3Q13 sales decreased 1.9% y-o-y to $238.4 million mainly due to a 17% decline in telecom revenues, though that was offset by a 10.5% increase in Datacom revenues. Telecom revenues declined due to a lack of demand for Finisar's telecom products as a result of sluggish growth in the telecom industry. However, datacom revenues increased due to growth in demand as businesses upgrade their technology infrastructure.

Gross profit margins declined by a hair's breadth to 29.3% (vs. 28.5%) due to a decline in average selling prices as a result of telecom price reductions (effective from Jan. 1). Furthermore, amd increase of 18% in amortization of the acquired developed technology (included in cost of goods sold) was due to the Red-C acquisition, which Finisar acquired in July 2012.

Operating income margins decreased by ~300bps y-o-y to 2% mainly due to an increase in research and development expenses (+9%), resulting from an increase in material costs related to new product development projects.

Capital expenditures increased 28%, driven by Finisar's new building in Wuxi, China. Capital expenditures are expected to be ~$32 million in Q4, primarily driven by the new building. During the quarter, it continued to invest significantly in new technology and products, especially in high-bandwidth products. Finisar is also continuing to invest in the development of next-generation wavelength selective switches that are smaller, use less power, and have a higher performance.

Liquidity remained sufficient, with cash on hand at $265.5 million sufficiently covering its $40 million convertible notes (conversion price of $10.675 per share).

For 4Q12 it guided sales of $235 million to $250 million with slightly lower gross margins of 30.5% (due to reduced telecom prices). Operating expenses should be ~$56.8 million, and Non-GAAP earnings per diluted share are expected to be $0.15 to $0.19 a share.

Competition

Finisar's two main competitors are JDS Uniphase Corp and Ciena Corporation .

Uniphase is a provider of communications test and measurement solutions and optical products for telecommunications service providers, wireless operators, cable operators, and network equipment manufacturers. On March 8, Uniphase acquired Arieso, which is a global leader in location-aware software solutions that enables mobile network operators to boost 2G, 3G and 4G network performance, for $85 million in cash. The acquisition complements Uniphase's open software platform, PacketPortal, creating a competitive advantage for mobile network operators and equipment manufacturers seeking a more cost-effective way to improve mobile service and reduce churn.

Ciena, which provides communications networking equipment, software, and services that support the transport, switching, aggregation, and management of voice, video, and data traffic worldwide, reported better than expected 1Q12 results on March 8. Stripping out one-time items, the company swung to a surprise per-share profit, sending shares up 7.2% to $16.02 in premarket trading. In the past couple of years, Ciena has faced losses due to rising expenses and integration-related costs. However, it started working its way up profitability following its 2010 purchase of Nortel Networks Corp.'s data and voice traffic transmission business, which doubled its workforce.

Conclusion

Finisar was recently downgraded by Jefferies, which changed its rating to underperform. According to Jefferies analyst James Kisner, the availability of silicon-photonics technology, which would enable a higher rate of data transfer and make optical components obsolete, was posing a serious threat to Finisar’s sales. As a result, according to him, companies like Cisco (which contributed to more than 10% of Finisar's FY12 revenues) and others are likely to be bigger threats to Finisar in the near term as these companies resort to vertical integration and launch competing silicon photonics-based transceivers.  When Chairman Jerry Rawls was questioned regarding this issue at the earnings call, he replied saying that he did not consider it as a major threat but only a technology that they had not used until now because it was not economical. He mentioned that the company was open to using it in its products in the future.

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