Finisar and Avanex spring into life

The first week of March marked the onset of some early spring growth for two of the compound industry s worst-performing stocks of recent years - Finisar and Avanex. Trading volumes went through the roof, with 80 million shares in Finisar (around a quarter of the company) changing hands on March 3 and a similar level of activity at Avanex. The market value of both companies doubled in the blink of an eye.

Why the sudden upsurge? Well, global warming might be changing some seasonal patterns, but it can t be held responsible for this one. The uptick coincided with the annual OFC/NFOEC trade show in Anaheim, and a deluge of public relations and marketing from fiber-optic component vendors of every kind. But that happens every year, and would have surprised nobody.

On the eve of this year s show, however, Finisar did report surprisingly good figures for its third quarter, which ended on January 31. Its stock price rocketed up more than 40% as a result of that, and dragged others, including Avanex, along with it.

Finisar made a profit of $8.3 million in the quarter. Yes, you read it right - a profit. That hasn t happened for a while, although it was correctly predicted by the company a couple of quarters back (see"Consumer diversification aids Finisar s march to profitability" Compound Semiconductor October 2005 p30). Analysts had only been expecting a breakeven quarter, hence the big spike. Another profit is expected in the current quarter, and the stock has maintained its value following the upswing.

Finisar s strength is not in exactly the same areas as other component manufacturers like JDSU, Bookham and Avanex, but the market seemed to take a wider view that all optical components were back in vogue, fueling a rise in stock prices across the whole sector.

The much higher volume of trading in Finisar shares may indicate that the big institutional investors could be taking an interest in fiber-optics again. CFO Steve Workman must have little idea who some of his biggest investors are, given the rate at which the stock has been changing hands. Workman described the company as "a little different" to other firms in the optoelectronics space at the company s recent investor conference call. With profitability, it can boast a certain financial uniqueness too.

The decision by Finisar to become vertically integrated came after the telecoms crash, when it acquired the VCSEL manufacturing operations of Honeywell and the Fremont, CA, InP facility formerly belonging to Genoa. This is now a cornerstone of the company s strategy.

Finisar paid just $3 million for the InP fab, while the previous residents had sucked up almost $100 million in venture capital. Crucially, the volume of long-wavelength InAlGaAs laser and detector chips being made in Fremont is now ramping. This is one of the big reasons why Finisar s gross and operating margins are so improved, and why the company has pulled its bottom line out of the red.

According to Joe Young, senior VP and general manager of Finisar s optics division, InP chip volumes in January 2006 were up 174% on January 2005. "Fremont is a big turnaround story for us," Young said. While volumes are currently at the 100,000 chips per week level, Finisar is expecting to make a lot more, he added. "We are investing in extra volume and increasing capacity."

The Richardson, TX, Advanced Optical Components (AOC) facility, where Finisar manufactures its 850 nm VCSELs, forms another critical part of the overall strategy. AOC s VCSELs are the acknowledged industry standard in datacoms, and Finisar is having mixed success in diversifying the applications in which they are used. Although the laser is featuring in advanced computer mice, with tens of thousands of integrated laser and detector chips shipping every week, Finisar admitted that scaling this volume up to the desired level of 100,000 per week is proving to be a struggle.

Communications will remain the key business driver for Finisar, however. Young expects that a strong ramp in the transceiver market of around 24% per year will propel company revenue upwards at a similar rate. Excluding passive optical networks, Young believes that Finisar s share of the transceiver market will have increased from just under 20% in 2004 to nearly 30% by the end of 2006.

Delivery of video content via the internet is going to be a critical consumer application that will drive volumes: "The big hog for bandwidth is video," explained CEO Jerry Rawls in the investor call. "Thirty minutes of video is equivalent to one year of email." All that video is going to require a lot of storage too, and luckily enough, products for storage-area networks are a big part of the Finisar business too. Meeting that anticipated extra demand is the challenge now, concluded Rawls: "The number-one topic is capacity, and we plan to increase this. We know from history that rising markets are generally underforecast by our customers."

Having control over its own laser and photodetector supply will give Finisar an advantage if demand increases faster than has been suggested. The company has made the vertically-integrated model work, but others in the fiber-optic components business still have much to prove.