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NeoPhotonics Corp. (NPTN) is a designer and manufacturer of PIC-based modules and subsystems for bandwidth-intensive, high-speed communications networks. It has a broad portfolio of over 300 products, including high-speed products. Speed and agility represented about 77% of revenue while access products represented about 23% of revenues.

Management is guiding towards y/y revenue growth during the fourth quarter. Revenue is expected to come in between $70M and $76M with the gross margin roughly in line with prior gross margins. But NPTN negotiates prices in the fourth quarter, which puts downward pressure on margins. The mid-point of the guidance implies 17% revenues growth.

Considering the fundamentals of business, including but limited to the missing third quarter SEC filing, I consider NPTN a short candidate. This is speculative grade asset. And I place the intrinsic value at 0.9 times book on a lack of operating profits and the potential need to raise outside capital. Currently, NPTN trades at 1.23 times book.

Recent Developments

  1. Ray Wallin was appointed senior vice president and chief financial officer. Wallin has more than 30 years of experience in the high technology industry.
  2. NPTN exhibited its small form factor Photonic Integrated Circuit based optical components for 100G Coherent Transport at the European Conference on Optical Communications. The small form factor products are designed to meet the requirements of high port density 100G coherent systems and to scale to 200G and 400G applications using higher order modulation schemes.
  3. NPTN reported record third quarter revenue of $76.8 million.
  4. NPTN and Inphi Corporation announced shipments to multiple customers of a new High Dynamic Range-Integrated Coherent Receiver in volume production. The HD-ICR is designed to deliver the high performance that is necessary for next generation 100G colorless coherent transmission systems.

Business Summary

NeoPhotonics is a leading designer and manufacturer of photonic integrated circuit based optoelectronic modules and subsystems for bandwidth-intensive, high-speed communications networks. The company's products enable cost-effective, high-speed data transmission and efficient allocation of bandwidth over communications networks.

NPTN has a concentrated customer base. There are three customers who comprised over 10% of revenue. Alcatel-Lucent comprised 18%, Ciena 13%, and Huawei Technologies 23%. In isolation, the concentrated customer base reduces NPTN's pricing power.

The business breaks down into the speed and access segments. Speed and agility products were about 77% of revenue. The 100-gig deployment is gaining momentum as carrier demand increases over time and service providers upgrade their core networks. China, although sluggish, is deploying a substantial amount of lines. But there are near-term growth concerns about both segments.

The filing of the third quarter 10-Q with the SEC was delayed. The stated issue is a real estate registration tax of approximately $0.5 million as a component of property, plant, and equipment acquired as part of the purchase of NeoPhotonics Semiconductor. The dollar figure is relatively immaterial, but it seems to be part of a larger adjustment to, and review of, financial controls, including personnel.

From a profitability perspective, the picture is ugly. NPTN is destroying investors' wealth, as low gross margins and high operating costs lead to operating losses. Depending on the cost structure, higher revenues could lead to margin expansion. But for the time being, I don't see a path to GAAP profitability.

In terms of liquidity at the end of the calendar second quarter, the cash ratio was 0.90, and the current ratio was 2.65. The remaining useful life of the plant, property and equipment was just over 6 years. Total debt to equity was 0.25, and financial leverage was 1.68. But there could be increases in the leverage ratios if NPTN fails to generate sufficient cash flow from operations.

Given the significant risks involved with investing in this company, I would charge NPTN a substantial risk premium for equity. The company would have to earn over $0.71 during the next twelve months, which isn't likely. I estimate that NPTN should destroy $1.30 per share of wealth.

Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in NPTN in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for NPTN's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in NPTN.

Portfolio & Valuation

NPTN is in a bear market but there are signs of an intermediate-term bull market, which may turn into a bull market of primary degree. These rallies are traps, in my opinion.

There can be some diversification benefits from investing in NPTN. The correlation since 2011 is -0.02. Since 2013, the correlation is 0.46. Broad market's uptrend has boosted shares of NPTN.

But variations in the share price of the S&P 500 have explained only 21% of the variations in the share price of NPTN since 2013. Since 2011, variations in the share price of the S&P 500 have explained 0% of the variations in the share price of NPTN. So, most of the variations in the share price of NPTN are explained by something other than the broader market's uptrend.

The 3-months, 6-months, and 12-months price targets are $5.11, $4.88, and $4.42. The current share price of $7.23 represents a 39% premium to the 12-months price targets. So, NPTN is trading above its downtrend.

On an absolute basis, paying 1.23 times book value appears inexpensive, or cheap. But considering the fundamentals of this business, I think it could trade below book value because there is substantial risk of the need to raise outside capital. Consequently, I could see NPTN trading at 0.9 times book value.

Source: NeoPhotonics: This Company Is Food For Bears