Optical Stocks: A Mixed Bag Toward 4Q06

by: Tiernan Ray

If Merill Lynch’s think piece on tech is too visionary for you, here’s a slightly smaller picture from Michael Genovese, telecom equipment analyst with Citigroup, who says results from fiber optic pioneers such as Ciena (NASDAQ:CIEN) and JDS Uniphase (JDSU) will be more or less in line with analysts’ expectations over the next several weeks, but who has some very specific things to say about the luminaries of the optical world. (Sorry, couldn’t resist.)

Eric has noted that reverse stock splits from these folks in recent weeks makes them look like DotCom era has-beens trying to get their shine back. Genovese is a little bit more bullish than all that, though he is selective in which stocks he likes based on earnings reports a couple months out. Genovese gives some specific comments about the main fiber optics plays:

Ciena: Ciena is tentatively scheduled to report FY4Q 2006 (October) results on December 21. Over the previous several quarters our checks into Ciena’s quarter with a week or two left to go indicated a strong likelihood of Ciena meeting or beating the quarter. In contrast, our current checks indicate that Ciena is still touch and go on the current quarter at this point and there are still some fairly significant orders that need to come in for Ciena to make the quarter. In other words, the best possible case at this point is that Ciena simply meets expectations. We will continue to monitor this issue over the coming weeks and plan to update our view in early November. We are not recommending Ciena’s stock at this point due to a potential revenue miss in the near-term as well as a lack of profitable growth longer-term.

Finisar (NASDAQ:FNSR): Finisar will likely report FY2Q 2007 (October 2006) results at the end of November. Overall, we expect the October quarter to be inline but are looking for much stronger revenue growth and margin expansion in the January quarter as the new Cisco 10G LAN program kicks in. Our FY2Q estimates of $110.7 million in revenues and EPS at $0.03 are inline with consensus. For January our published estimates of $115.5 million and $0.04
compare to consensus at $114.5 million and $0.04 and we see potential for even more
revenue upside than we currently have in the model. For the October quarter our GMs estimate of 37.7% compares to the guidance range of 37.5%-38.5%. For the January quarter we are looking for significantly stronger GMs expansion to 38.8%. Finisar remains our top pick in the Optical space and we recommend buying the stock aggressively below $4 per share.

ADC Telecom (ADCT): ADC will likely report FY4Q 2006 (October) results at the end of November. Our estimates of $305 million in sales and EPS at $0.19 compare to consensus at $304 million and $0.18. We expect a more or less inline quarter from the company as well as inline sequentially down guidance for FY1Q. Consistent with our investment thesis on the stock, we are looking for an upturn in North American and European carrier triple play spending in 1H CY 2007 to drive outperformance in financial results and expect more or less inline results before that in CY 2H 2006.

JDS Uniphase: JDSU guided to $312-$328 million in FY1Q sales. Our $326.3 million estimate is above consensus, which stands at $321.6. Our estimate is based on checks into the Optical business, which suggest another strong quarter of demand with continued capacity constraints, combined with management’s comments around the reverse stock split that it would only implement the reverse if it saw continuing EBITDA improvement. In our view, the fact the company did the reverse implies that revenues should at least be within the top half of the guidance range. Our EPS forecast of $0.02 for the quarter compares to consensus at $0.01. We note that if JDSU does produce an EPS profit for the quarter this will be the first EPS profit in five years at the company. We expect the December quarter to mark the first positive operating margin in over 5 years at JDSU. Given the pullback JDSU shares have seen in the past week following the reverse stock split we view the stock as attractively valued and recommend buying the shares aggressively in front of the FY1Q earnings report. Consistent with our investment thesis on the stock, we are looking for an upturn in global carrier triple play spending in 1H CY 2007 to drive outperformance in financial results and expect more or less inline results before that in CY 2H 2006.

Actually, the most interesting part of what Genovese has to say is that with the tech IPO back in style, all these companies will have to contend with increasing competition when a startup called Optium (OPTM) prices its IPO, supposedly on Thursday:

This company was started by engineers that left JDSU to form Optium. While Optium competes in several product categories nearly all its sales and growth is being driving by pluggable optical modules in the 300 pin form factor. While Optium does not directly compete with JDSU and Finisar in the major portion of its business, we think over the near-term Optium could compete for investor capital with these two companies.

But at least for the moment,

However, the Optium deal does not change our fundamental view of Finisar or JDSU. We continue to expect the January quarter to be a watershed for Finisar and we are strongly recommending the stock. For JDSU, we think investors now have a highly attractive entry price following the reverse stock split and the buzz around Optium. While it is difficult to call the precise near-term bottom, we think buying JDSU in the $14-$15 price range is a great opportunity and we recommend buying the stock on any additional related weakness.