As a conservative value investor, I rarely bang the table. But now I’m using a jackhammer because overlooked optical components manufacturer Oplink Communications (OPLK) offers the best opportunity for a double in a year and far more in 2-4 years—with a margin of safety—than any investment I know today.
You have the trifecta—high growth, cheap valuation, and a margin of safety—available at today’s $13 price. Yet investors—speculators?—prefer the profitless and prospect-less JDS Uniphase (JDSU), Avanex (AVNX), and Bookham (BKHM), or the outrageously valued Ciena (CIEN) or Harmonic (HLIT) to this cash-rich, exploding, well-managed and cheap company whose management brought it through the telecom depression with a pristine balance sheet.
Now Oplink is enjoying the fruits of its survival skills. With big telecom network spending recovered and growing at a healthy rate, Oplink’s biggest customers include Nortel (NT), Huawei, and Tellabs (TLAB). Their orders fuelled Oplink’s eight straight quarters of double-digit sales gains, the last four accelerating at 85%, 81%, 89%, and 120% year-over-year, with firm gross margins and rising net margins.
The margins are what bring us true cash riches. When we take Warren Buffett’s owner’s earnings, also called structural free cash flow (SFCF), we find Oplink in hypergrowth mode as well. This brand of FCF metric, calculated as net income plus depreciation and amortization minus capital expenditures, has exploded 171%, 160%, 142% and 96% year-over-year for the last four quarters. Oplink’s EV/SFCF multiple is a giveaway 3.4, and ex interest a still laughably cheap 6.
With 80% of the share price in cash, no debt, and triple-digit sales and free cash flow growth, Oplink is very attractive to a buyer. Using the buyer’s familiar EV/EBITDA yardstick, Oplink’s multiple of 6 could easily bring a buyer for 10 or more. A suitor performing a discounted cash flow analysis could easily see clear to paying in the $20s a share—80% to 100% higher than today’s price—or three or more times today’s $13 assuming any kind of growth in FCF going forward. This provides a shareholder today both an excellent margin of safety and phenomenal opportunity for gain.
All good, but if the investment case is so strong, why are investors letting shares languish, eschewing the highest growth, best free cash flow, and greater margin of safety with the best upside of any stock in the industry, let alone highly favorable right now for any investment? Why are shares down from the $20s to $13 when growth is accelerating?
Investors most-likely have fled Oplink due to misplaced concerns that Oplink’s acquisition of Optical Communication Products (OCPI) may slow earnings for a few quarters. A few quarters are nothing to those knowledgeable about the company—I’ve owned shares for four years—who have proof of management’s conservative acquisition strategy, many-year track record of conservative cash management, and extraordinary financials and major metrics. Investor caution is our chance for success.
True, integration of OCPI may take up to a year, but there is every reason to believe that this acquisition, unlike 80% of them, will add shareholder value. Oplink management has considered and rejected several targets over the years—notably Avanex, a target Oplink ran from with what we see in the rear-view mirror was extraordinary judgment: Avanex is cash-destroying, while Oplink is cash-minting.
We know that CEO Liu has considered and rejected one after another during a period in which cash-rich Oplink has had the pick of the litter. That he has settled on OCPI tells us that this company is the right fit at the right time. Plus, not only did Oplink pay not much over tangible book for OCPI, but that pittance will turn out to be a fire sale price if Oplink can eliminate the cash burn and incorporate OCPI’s products and customers.
Given its accomplishments with its own transformation after the telecom bubble burst, Oplink is odds-on to achieve the same with OCPI. Along the way, OCPI’s complementary businesses also give Oplink a wider product line to sell to a larger customer base. And with Oplink’s own organic growth, even the most unlikely case—complete failure of the acquisition—will leave Oplink little to no worse off.
With a market cap of $300 million and enterprise value of $70 million, Oplink is a small cap value and growth diamond. Growth of this caliber just doesn’t come this cheap or for long. With patience, investors have an excellent opportunity for a double in 12-18 months and a triple or more in 2-4 years with continued business momentum.
Small-cap value-oriented hedge fund managers won’t ignore this forever, and patience will be rewarded.
This article was written by Tom Jacobs.
Disclosure: Tom Jacobs owns shares of Oplink in Complete Growth Investor’s real-money Margin of Safety Portfolio.
