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Summary

  • Finisar has a solid clientele that includes the likes of Cisco and Ciena.
  • Finisar is launching faster and more efficient products in the market to benefit from the build out of networking equipment and data centers.
  • Cisco’s Internet of Things could be a big driver for Finisar.
  • Finisar’s vertical integration is also an advantage, providing a wide portfolio of products and strong margins.

Finisar (NASDAQ:FNSR), a maker of fiber optics components, has soared this year due to solid data spending and a turnaround in its telecom business. Since Finisar counts the likes of Cisco (NASDAQ:CSCO) and Ciena (NYSE:CIEN) as clients, it is not surprising to see that the company has appreciated more than 17% this year as these equipment makers are well-positioned to benefit from the data boom. Moreover, Finisar is looking to grow its business through both organic and inorganic means.

This has resulted in solid revenue and earnings growth so far. In the last reported third quarter, its revenue was $294 million, up 23.4% year-over-year. In addition, non-GAAP gross margin increased to 37.2% from 37.1% in the preceding quarter. Looking ahead, this terrific performance can be expected to continue due to a variety of reasons.

Inorganic growth

Earlier this year, Finisar had acquired Berlin-based u2t Photonics. Finisar added u2t's Indium-Phosphide-based, high-speed receivers and photodetectors, including the industry-leading 100G and 200G coherent receivers that are used by multiple system manufacturers. In addition, this acquisition consolidates Finisar's previously announced partnership with u2t on Indium-Phosphide-based Mach-Zehnder modulators for 100-gig and 200-gig coherent applications.

These receivers, photodiodes, and modulator technologies and products, combined with Finisar's narrow-band tunable lasers, provide a full suite of vertically integrated optical components. This would help Finisar offer its customers high-performance modules for the 100G and 200G coherent metro and long-haul markets.

Apart from using these components for OIF discrete 100G and 200G applications, Finisar will utilize key components in its CFP2 coherent modules, as well as new form factors, such as CFP4 and QSFP28 and SFP+ for next-generation telecom and datacom applications.

The acquisition of u2t is seen as strategically important because it helps Finisar provide a differentiated vertical-integrated solution to address the 100-gig coherent transceiver market. This market is expected to be worth more than $500 million by 2017, according to LightCounting.

Product development moves

Finisar is also making significant strides in new product development for both datacom and telecom products. As a result of Finisar's vertical integration of lasers, receivers, and optical subassemblies, its modules consume very low power in datacom. To build upon its product development in this sector, Finisar released its 100G CFP2 LR4 solution. In addition, the 100G CFP4 and QSFP28 module developments are also progressing well and continue to be designed into new applications with its parallel optical engine product that operates at up to 28 gigabits per channel.

In telecom, Finisar is now shipping its beta samples of tunable SFP+ modules that are utilizing its internal low-power tunable lasers and optical subassemblies, which consume total power of approximately 1.5 watts.

Finisar's revenue is driven primarily by growth in the worldwide demand for bandwidth, with the ever-increasing distribution and use of video, images, and digital information. The growth in cloud services with larger data centers and an increasing number of longer, high-speed connections is another important trend that is benefiting Finisar. This increase in optical content and data centers creates more opportunities for Finisar products, since the company generates more than 71% of its revenue from data communications products.

With more than 500,000 data centers already present across the globe, Finisar has a good opportunity ahead since these data centers would need to be upgraded to handle increasing data. Moreover, the data center construction market is expected to grow at a CAGR of 7.6% till 2016, and this is another key factor that could contribute to Finisar's growth.

Over time, it is believed that both enterprise and carrier capital spending will increase to provide more bandwidth capacity, and Finisar is well positioned with its broad product portfolio, extensive customer engagements, a profitable and vertically integrated business model, and a strong balance sheet to capitalize on these market opportunities. So, it is not surprising to see that Finisar's revenue for Q4 is expected to grow for the seventh consecutive quarter.

Cisco's role

Moreover, for the long run, Finisar is looking very bright. Cisco is a major customer of Finisar and had accounted for more than 10% of revenue in the previous quarter. This fact had weighed on Finisar's shares earlier when Cisco reduced its three to five year revenue growth target from 5%-7% to 3%-6%. But Cisco is aggressively focusing on the Internet of Things and this could be an advantage for Finisar in the long run. Cisco expects the Internet of Things to become a $19 trillion market by 2020, and the company is looking to tap this opportunity by selling more networking equipment as more devices come online.

Cisco has already rolled out nearly $180 billion worth of network equipment globally and wants to leverage this strong install base to create new opportunities. In addition, Cisco's cloud networking platform has been growing rapidly, growing over 100% year-over-year and more than doubling customers from 4,300 one quarter ago to 9,600 in the last quarter. So, Finisar can expect strong growth from Cisco going forward.

Valuation and conclusion

Finisar's trailing P/E and forward P/E is 28.49 and 14.33, respectively. This indicates earnings growth in the future. Also, the PEG ratio of 0.60 is very impressive, signifying under valuation. Considering the opportunities that the company has, it can be a good long-term pick and continue appreciating on the back of a solid client such as Cisco and growth in data.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.