Infinera's Significant Competitive Advantage

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Includes: AVNX, BKHM, INFN, NOK, NT, VIAV
by: Andrew Schmitt

Infinera (NASDAQ:INFN) had a very successful first day of trading after seven years of working counter to the popular and misguided beliefs of a Gilderesque, all optical future.

Great controversy surrounds the company and investors wonder whether the valuation attached to the company is justifiable. The valuation is indeed debatable and is predicated on their success penetrating the PTT’s & Bellcos.

However, I feel this is a real company with a significant competitive advantage derived from their early attempt to use integrated photonics as a disruptive technology. Their key differentiation was dropping the cost of optical to electrical conversion (see 'Death of the All Optical Network') and building a system that leveraged this strength.

What is most interesting about Infinera is that they are, at their core, an optical component company. The company was founded on the concept of making a highly integrated optical transponder and then building an entire hardware/software system and carrier marketing and sales team around it.

As an optical component company, they would be throwing their lot in with JDSU (JDSU), Bookham (BKHM), Avanex (AVNX) and other companies inhabiting the arid plain of unprofitability that is the optical component business. Instead, Infinera made the component the competitive advantage, and successfully raised the $315M in venture capital needed to build an optical transport equipment company. Amazingly, this was done in a period of time when the optical sector was kryptonite to most investors.

As a result, Infinera is currently in a better position than any other transport company to deliver low-cost, high-density optical transport. Their Photonic Integrated Circuit [PIC] allows them to offer ridiculously high port densities of 100G per slot.

The 100G number is important as it gives them architectural flexibility to meet both the emerging 100G Ethernet standard or the 40G SONET/SDH standard (or a derated 100G Ethernet specification). It also lets them deliver 10G in great quantities and theoretically, low cost. These low-cost 10G links can be bundled together using inverse multiplexing to form 40G and 100G links that don’t require new bleeding edge optical components.

Conversely, most of the incumbent optical transport companies like Alcatel/Lucent (ALU), Nortel (NT), and Siemens have focused on more incremental improvements during the post-bubble years. To make matters worse, these companies, with the exception of Huawei and ZTE, have outsourced their optical component R&D to their suppliers, leaving them with no way to differentiate themselves at the optical layer (see 'Dr. Strangelove, Or: How I Learned to Stop Worrying and Love Huawei'). This has left the former titans of optical transport defenseless.

I remember a meeting with Infinera (Actually called 'Zepton' before a savvy marketing guy changed the name of the company) way, way back where Drew Perkins laid out an array of optical modules on the conference room table. He pointed at each one, and said that they were way too big with some very colorful language. He indicated that they wanted to build a 100G linecard- this was at a time when 10G was considered state of the art. These modules wouldn’t get the job done so they were looking at ’something else’. Chip companies asked to build 100G electronic components to feed the ’something else’ snickered at the lunacy of it all.

If Infinera is successful, it will be a classic example of the Innovator's Dilemma.

I predict this IPO will drive interest in PICs and several component vendors will attempt to piggyback on the market success of Infinera. But I expect that this new technology will not change their fortunes.

Why? Infinera built a defensible business and extracted the value from an innovative optical component. These standalone component companies will continue to slug it out in an oversupplied commodity market. Once PLC’s are commoditized, Infinera will still have a differentiated system that leveraged the density strengths of the PLC. And other equipment vendors will be playing catch up.

Congratulations, Infinera.

Disclosure: Author owns no position in the companies mentioned