Tuesday, January 1, 2013

Finisar is Starting to Look Interesting

Communications company Finisar Corp (NASDAQ: FNSR) gave results and the market appeared to like them. However, I think it looks a bit more like a relief rally than an affirmation that there was anything in the results to suggest that the corner had turned on the Telco spending side. At some point it will -- the demand for bandwidth and data rich devices shows no sign of abating -- but in summary, I don’t think you can adduce much from these results.

Finisar’s Q2 Results

As ever, the results need to be put into context of what the market was expecting. A brief summary.

  • Q2 Revenues of $232 million vs. estimates $231.8 million
  • Q2 Non-GaaP EPS of 15c vs. estimates of 14c
  • Q3 Revenue Guidance of $230-245 million vs. analyst estimates of $239.5 million
  • Q3 Non-GaaP EPS Guidance of 14-18c vs. estimates of 17c

So it’s a revenue and earnings ‘beat’ but the mid-point of guidance is lower than analyst estimates. What makes Finisar interesting is the guidance and color it usually gives on its Telco and Datacom verticals. And investors have been given mixed signals on the issue recently. For example, Cisco Systems (NASDAQ: CSCO) has spoken of signs of conditions getting better with US carrier spending, but if so we haven’t seen it in the CapEx guidance from the major carriers in the US. Along with the rest of the sector, Finisar had been looking for a pick-up in its end markets in the second half from a combination of increased US carrier spending and Chinese stimulus spending.

In order to see what is going on I have broken out Datacom and Telecom revenues for Finisar.

This is one of those situations where the optics of a graph needs explaining. Datacom’s growth appears to have slowed to high single digits and looks flattish sequentially. This could be seen as disappointing because data center CapEx has been steadily improving this year. However, Cisco too said that its latest quarter was more of a natural slowdown in data center spending than any kind of trend change, and from what I’ve seen of Equinix’s and others' gross margins that appears to be the case. I'm willing to accept this as a one-off quarter.

Telco Spending Still Cautious

The optics also needs explaining with regards Telecom. Although the sequential up-tick looks good, it is no more than usual. This chart explains all.

There has been some market chatter with regard to increased spending at AT&T (NYSE: T), and there has certainly been some positive rhetoric on that front. However, we haven’t seen it yet and Verizon (NYSE: VZ) also lowered its CapEx spending for the full year.  In truth I suspect both will watch the macro-economy and keep their ears tuned to their customers’ gripes over the fiscal cliff and other sources of economic uncertainty.  Bellwethers aren’t called bellwethers without reason and that usually is due to their sensitivity to the global economy.

Finisar’s Operational Performance

Having discussed the macro read from Finisar’s results, it’s time to turn to some operational specifics. As ever, these things are somewhat guided by the top line. A couple of years ago, Finisar was hoping for something closer to 36% but they are now coming in nearer 30%. No matter, the new manufacturing facility in China should help margins in the future as will as increased spending from customers ramping up to 100G from 40G.

As for the competition, the decent Telco numbers (historically tracking but let’s recall that the environment has gotten weaker throughout the year) were seen in some quarters as being the result of winning market share from others in the industry. Finisar refused to be drawn into discussing specifics on the conference call, but it did imply that it had won market share. I suspect we will see that some of it came as a result of pricing in the next quarter (my reasoning being that management claimed that the growth in Telcom and Datacom revenues ‘might well be on par’). If so, then any significant margin erosion (from telcom pricing) would show up by then.

The Bottom Line

Unfortunately there isn’t anything in these results to suggest a corner has been turned in telco spending, and the slowing in growth in datacom (although in line with industry peers) may well unsettle some nerves. At some point in the longer term this will change, because the rise in bandwidth demand is only going to go up with things like smartphone and tablet penetration rates and the increase in data rich applications.

The question is whether Finisar is the way to play this or not.  Moreover, I suspect there will be plenty of time to get in but it would be nice to see some firm evidence of conditions getting better first.

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