Avanex Should Become a PR Company for Sycamore

Includes: AVNX, SCMR
by: David Jackson

I shorted Avanex (AVNX) in November 2003, and again in January 2004. I'd left Morgan Stanley where I'd worked as a sell side analyst covering the optical component and equipment stocks, including bubble flare-outs Avanex and Sycamore Networks (NASDAQ:SCMR). Avanex is now a cash consumption machine, and Sycamore has become a tax-inefficient money market fund. (It's sitting on a pile of cash on which it earns lousy returns).

Now, three years later, I'm still holding that Avanex short position. Demand for optical components is muted, VCs created future competition by pouring money into optical startups long after the bubble burst, and Avanex saddled itself with an impossible cost structure by buying factories from Alcatel Optronics in France. Its management team has been in constant flux, culminating in the CFO departing a few days ago. By "the CFO", let's be clear: Avanex is now on to its third CFO this year!

The company has lost money every quarter since I remember shorting the stock. In fact, it's lost money in every one of the 26 quarters since it went public, a total of about $680 million. And since the IPO, Avanex insiders have sold about $620 million worth of stock. According to The Mercury News:

On Oct. 2, six Avanex insiders sold a total of $281,074, primarily as part of Rule 10b5-1 trading plans they adopted earlier in 2006. They were led by CEO Jo Major, $58,208; Chief Financial Officer Calvin Richard Hoagland, $51,563; and Chief Technology Officer Giovanni Barbarossa, $47,196. That brings total stock sales by the six Avanex insiders to $1.37 million in 2006.

Sometimes the stock tanks on the realization that it's a cash-suction hole. Sometimes it rebounds when the company raises money to keep itself alive (at the cost, of course, of more dilution for shareholders). And sometimes the stock rockets when "theme" investors decide that Avanex just must benefit from all that bandwidth-gobbling video on the Internet.

So I read Avanex's earnings press releases with great interest. And tonight's press release is a gem. In Q3, we learn, the company generated revenue of just under $51 million, of which $13.5 million was sold to "related parties". Gross margin was a pathetic 9%. R&D expense on its own exceeded gross profit. Total operating expenses were more than three times gross profit. The net loss, $9.8 million, was almost 20% of revenue! And even the "non-GAAP" net loss was $7.2 million.

Outlook for next quarter: "The company expects revenue in the second quarter of fiscal 2007 to be between $52 million and $55 million and expects gross margin to improve." Wow. That's reassuring. Gross margin has to improve by about 300% to get this company to break-even.

With all this red ink and still no profitability in sight, you'd expect a rather sombre press release. But what's the headline?

Avanex Announces Record Revenue for Q1 Fiscal 2007

And here's the juciest part of the press release:

"I am very pleased with our performance this quarter as it marks the company's third consecutive quarter of double-digit revenue growth," said Jo Major, chairman and chief executive officer of Avanex.

"During the quarter, we saw strong growth from new products we announced including our amplifier with integrated optical monitoring capability developed for next-generation deployments that provide the network backbone for the delivery of high-bandwidth triple play services. Also during the quarter, our supply chain initiatives started to take hold, helping reduce our overall product cost. Our operational metrics including yield, on-time shipments and return rates continued to recover following last year's manufacturing transition," said Major.

Not a comment about the recurring losses, or the CFO departures, or the lousy outlook. Rather, "I am very pleased with our performance this quarter".

Perhaps someone should suggest on the conference call that Mr. Major sell all those money-losing optical component factories, give the cash back to the shareholders, and go into the PR business instead. Sounds like he's got real talent at what they call "spin".

Perhaps he could market the Sycamore Money Market Fund.

Full disclosure: short Avanex at time of writing.