Applied Optoelectronics (AAOI) made its public debut on Thursday the 26th of September. Shares of the provider of fiber-optic networking products ended their first day with losses of 0.4% after trading with losses of upto 6.3%.
You can easily call this a "failed" public offering, as shares were offered at a significant discount compared to the preliminary offer range. At these relatively low sales multiples, I remain cautiously optimistic. Depending upon the outcome of further research and the release of the next quarterly results, I might initiate a long position in the future.
The Public Offering
Applied Optoelectronics provides fiber-optic networking products, as the company focuses on cable television (CATV), fiber-to-the-home, and internet data centers.
The company designs and produces optical communication products at different levels of integration. The company is focused on the higher-performance segments, which demand faster connectivity and are driven more by innovation.
Applied Optoelectronics sold 3.6 million share for $10 apiece, thereby raising $36 million in gross proceeds. All shares were being sold by the company, with no shares being offered by selling shareholders. If underwriters exercise their 15% over-allotment option, those shares will be delivered by selling shareholders.
Bankers and the firm set an initial price range of $13 to $15 per share. Shares were eventually sold below the low end of the range.
Some 29% of the total shares were offered in the public offering. At Friday's closing price of $10.10 per share, the firm is valued at $127 million.
The major banks that brought the company public were Raymond James, Piper Jaffray, Cowen and Company and Roth Capital Partners.
Applied Optoelectronics focuses on three end markets, as mentioned above. These end market are driven by increased demand for bandwidth driven by connected devices, video traffic and cloud computing, among others.
Cable TV providers and general telecommunication service providers are competing directly, offering bundled packages to their subscribers. To cover all the increased demand, fiber-optic networking technology will become crucial in these three markets, according to Applied Optoelectronics.
The CATV market is the largest market for Applied Optoelectronics, as Applied is the leading provider of optical components and the second largest provider of subsystems, according to research firm Ovum Limited, to be found in Applied's S1-Filing. The shift in outsourcing of these sub-assemblies by equipment vendors have increased the addressable market for the company significantly in recent times.
For the full year of 2012, Applied Optoelectronics generated revenues of $63.4 million, up 32.6% on the year before. Net losses narrowed from $5.3 million in 2011 to $1.0 million over the past year.
Revenues for the first six months of 2013, rose by 20.5% on the year before, coming in at $33.9 million. The reported growth rate implies a significant slowdown from the 32.6% growth rates reported in 2012. Net losses doubled to $1.3 million in the meantime.
Applied Optoelectronics operates with $10.9 million in cash and equivalents, while the company operates with $25.9 million in total debt. Factoring in gross proceeds of $36 million, the company will operate with a net cash position of around $15 million. Some $13 million of gross proceeds will be used to repay indebtedness with interest rates ranging between 4.375% to 6.875%.
As such, Applied Optoelectronics' operating assets are valued around $112 million, the equivalent of 1.8 times last year's annual revenues.
As noted above, the offering of Applied Optoelectronics has been disappointing. Shares were offered some 28.6% below the midpoint of the preliminary offering range. Add to that the 0.4% opening day losses, and shares are trading with losses of 28.9% compared to the midpoint of the preliminary offering range.
Besides Texas, the company has operations in China and Taiwan, creating a vertical integrated manufacturing model. This approach has advantages in terms of rapid product development, quicker response times and control over quality. Through its own Molecular Beam Epitaxy fabrication process, Applied is unique in the industry, accompany to the company itself.
The approach of the integrated model has some drawbacks as well, resulting in relative low gross margins which fell by 170 basis points to 29.6% of total revenues in the first half of this year. This is due to the high fixed costs, as almost 70% of the company's 927 workers are employed in the manufacturing facilities. Gross margin compression hurt as operating expense rose by 20 basis points to 31.5% of total revenues.
Another key risk is customer concentration, not an unusual risk for smaller companies. Cisco Systems (CSCO) which is a key customer in the CATV market, generated 33.2% of total revenues over the past year. At the same time the top 10 customers, represented 79.2% of total revenues in the first half of 2013. For the first half of 2013, the company generated 55.4% of sales from the CATV market, 30.5% from the internet data center solutions, and the remainder from the FTTH market and other products.
The slowdown in revenue growth for the first half of the year to just 20.5% is a bit worrying. This was caused by weakness mostly in the CATV market in China, due to mergers of some of the company's customers. Second quarter revenue growth accelerated to 25.3% as revenues were up nearly 37% on a sequential basis.
While the market is extremely disappointed with the public offering, I am a little bit more optimistic. The revenue slowdown in the first half of the year was severe, but growth re-accelerated in the second quarter. The $112 million valuation values operating assets around 1.5 times $75 million in expected revenues for the calendar year of 2013.
Given the low revenue multiples and the fact that Applied Optoelectronics is approaching the break-even point, the company might be attractive. I might do some additional research on the company's products and competitive position before possibly initiating a long position in the firm.