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III-V Shares Head South

During the last 12 months the share prices of all the leading III-V chipmakers have fallen. But why has the value of some companies dropped by just a few percent, while others have plummeted by more than two-thirds? Richard Stevenson investigates.



It’s been a tough 12 months for everyone owning a portfolio of III-V shares. The share price of all the leading, publicly traded players in the compound semiconductor market has fallen in the year leading up to April 30, 2012, and in a few instances, share prices have lost more than half their value.

In some cases, it is easy to understand the lacklustre performance. The LED industry is suffering from overcapacity, which drives down chip prices and squeezes margins. And unfortunately, until solid-state lighting really takes off, this sector is going to resemble a bloodbath. What’s more, the pain felt here also has knock-on effects, such as declining MOCVD tool purchases, which hits the likes of Aixtron and Veeco.

However, in other sectors of the III-V industry, it is not as obvious why share prices have fallen across the board. For example, total revenue in the GaAs microelectronic market is expected to rise by about 6 percent per annum for the next few years, according to market analyst Strategy Analytics. However, this rise in growth is far less than the 35 percent hike in 2010, and it is probably this deceleration that is behind the drop in share prices.

The return of telecos?

The company that performed best over the last 12 months is Infinera, a manufacturer of large-scale InP photonic chips, which it uses to build its own systems, primarily for long-haul optical networks. The share price of this firm, which is based in Sunnyvale, California, has hovered between $6 and just over $8.50 during the last year, and fell by just 2.4 percent during the period of evaluation employed for the construction of the Compound Semiconductor Share Price Leader Board (see table 1).



Table 1. In the last 12 months none of the compound semiconductor chipmakers has performed better than the NASDAQ

Although this vertically integrated player in the telecommunications sector is topping the table, its financial results are far from impressive. For example, in its 2011 fiscal year that ended on 31 December 2011, company sales were $404.9 million, down from $454.4 million for the previous year, while losses increased from $27.9 million to $81.7 million and gross margins fell from 45 percent to 41 percent.

This trend is maintained in the most recent quarterly results, with sales of $104.7 million, losses of $11.2 million and a gross margin of 40 percent for the first quarter of 2012. Operating in this manner is eroding the company’s reserves: At the end of quarter one, 2012, the value of cash, cash-equivalents-restricted-cash and investments fell by $13 million to $240 million.

However, Infinera’s management team has good reason to be very optimistic about the company’s long-term future. It’s operating in a market that is widely tipped to undergo tremendous growth, and it has recently launched unrivalled products that are attracting attention.

The later point was discussed in more detail in a conference call following the company’s first quarter 2012 results. In that call, Infinera’s CEO and President Thomas Fallon cited three reasons for traffic growth in optical networks: The cloud, mobile and video.

According to Forrester Research, a market analyst firmbased in Cambridge, MA, the cloud service market could be worth almost $240 billion by 2020.  And with most applications in future expected to be based in the cloud, bandwidth in networks will have to grow to be large enough to accommodate massive, short-lived hikes in data transfer to deal with any disasters.

The second driver cited by Fallon for the growth of optical networks, mobile traffic, is growing rapidly thanks to tremendous growth in the sale of smartphones, tablets and laptops with a wireless connection. Data usage is tipped to increase 18-fold by 2016, and to support this, their has been a massive rollout in 3G, 4G and Wi-Fi networks. Mobile communication is not exclusively wireless, however, as data is also routed through an optical backbone.

Thirdly, Fallon argues that optical capacity must increase to cater for the growth of streaming video from multiple sources: User-generated content, such as that found on YouTube; aggregators, including Netflix and Amazon; and content creators, such as NBO. Video quality is increasing from standard definition to high-definition, with 3D just around the corner, and it is inevitable that this trend will contribute to the rise in data transmitted through optical networks.

To cater for this, investment in optical transport is on the up. For example, 19 million miles of optical fibre was deployed in the US in 2011, the most since 2000, according to the London based analyst CRU Group. This fibre will need to be ‘lit’, and Dell’Oro Group of Redwood City, CA, predicts that this should drive a 10 percent per year growth in the DWDM (dense wavelength division multiplexing) market through to 2016. Within this sector, optical packet transport is tipped to grow at 22 percent, which is great news for Infinera’s latest platform, the DTN-X.

Fallon argues that this platform is three products in one. Firstly, it is a DWDM transmission system that can support 500 Gbit/s ‘super-channels’ based upon 100 Gbit/s FlexCoherent channels. In addition, it is an integrated OTN (optical transport network) switching system, which will initially have a capacity of 5 terabits, but eventually have an upper limit of 100 terabits. “This will enable operators to tame these large pipes, through the grooming of traffic down to 1 Gigabit granularity," explained Fallon. Lastly, the system is designed allows upgrading to MPLS (multi-protocol label switching), a step that can improve network efficiency.

By late April, Infinera had four purchase orders for DTN-X systems – three with existing customers, and another with a new customer, Cable&Wireless. In addition, several other potential purchasers were in active contract negotiations with the company.

Infinera expects shipments of the DTN-X to take off, with sales appearing on quarterly balance sheets in the second half of this year. Interest in this platform has already led to a cut in orders for the forerunner, the DTN, and Infinera is ramping production of components for the new system. This state of affairs is expected to lead to a small fall in revenue to $92 million to $100 million for the second quarter 2012, and a loss of $16 million to $21 million for this period. But the longer-term prospects are more positive, with revenues for the second half of this year expected to be in the range $230 million to $250 million.

If this trend can continue, with Infinera’s shipments of the DTN-X increasing rapidly while gross margins fall through greater economies of scale, the company’s share price seems destined to head north.  This will be welcomed by long-term investors, who have maintained faith in Infinera’s disruptive technology and are looking for a good return on shares that they bought back in summer 2007 for $13 when the company had its initial public offering.

 

Above: Infinera’s recently launched DTN X combines: A DWDM transmission system that can support 500 Gbit/s ‘super-channels’; an optical transport network switching system; and an opportunity to upgrade to multi-protocol label switching, a step that can improve network efficiency

Reaching skywards

Skyworks, in second place with a fall in share price of 12 percent, has seen the value of its stock plummet from April 2011 until the end of that year, and climb steadily ever since (see Figure 2). Two strong quarters have helped that recovery. For the first fiscal quarter 2012, which finished on December 30, 2011, the company reported sales of $393.7 million, up 17 percent year-over-year, plus a profit of $96.2 million. Results for the following quarter, which is traditionally weaker, were equally impressive: Sales of $364.7 million, up 12 percent year-over-year, and a profit of $79.8 million. In addition, during those three months the company has paid off the lasts of its debts.

 

Figure 1. Infinera’s share price has been steady over the last 12 months

 

Figure 2. Skyworks share price has been a tale of two halves: heading south in the latter part of 2011, but climbing back up during the start of this year

 

Figure 3. Oclaro has had a bad 12 months on the stock market.Will the merger with Opnext turn the situation around?

One of the big, recent changes at Skyworks that has helped the company to grow its revenue is diversification, both in terms of products and addressable markets.

Part of this move has involved the $200 million cash acquisition of Advanced Analogic Technologies, which will allow Skyworks to compete in the $2 billion market for power managements ICs used in displays.

“We are clearly not just a PA company [anymore], but rather a full-service RF and analogue specialist focused on mobile Internet and adjacent high-growth market opportunities," explained David Aldrich, Skyworks’ president and CEO in a conference call discussing second quarter 2012 results.

Aldrich went on to give an example of the expanded deployment of Skyworks components in handsets. According to a teardown published by Chipworks, the Galaxy Note from Samsung contains an RF engine produced by Skyworks, plus the company’s antenna switch module, band switches, GPS low noise amplifier and a wireless networking front-end module.

In cases like this, where Skyworks provides a rafter of products into a single design, its total sales per handset can be $10 or more. And this trend of increasing the dollar-content-per-phone looks set to continue, due to a rise in the number of frequency bands built into smartphones – one design that Skyworks has seen sports a staggering 23 bands.

Sales of smartphones continue to rise, and shipments could hit 4 billion units between 2011 and 2015. This will help to swell Skyworks’ revenue, which should also grow as the firm ships more and more wireless radios into an incredibly wide variety of non-mobile segments that extend beyond just gaming, PCs, TVs and set-top boxes.  Earlier this year, the company announced design wins in the entire line-up of General Electric smart appliances, including washers, dryers, refrigerators, dishwashers and ovens. In addition, products from Skyworks are featuring in a remote heart monitoring device from Medtronic, radio applications for emergency responders and Ericsson basestations.

All this activity will help to increase Skyworks’ sales, which are expected to hit $383 million in the third quarter 2012. Alongside this revenue growth, the company expects improvements in gross margins that should spur the next quarter’s profit to about $84 million.

Diversified tools sales

Third on the leader board is French manufacturer of deposition equipment, Riber, which has seen the value of its shares drop by 18.5 percent in the 12 months leading up to 30 April 2012. Over this period there have been no wild swings in share price that has been a little higher in 2012 than it was in the latter half of 2011.

Riber reported strong results for the last fiscal year, which finished on 31 December 2011. Sales of MBE systems rose by a modest 4 percent, but revenue for cells and sources leapt nearly four-fold. Investment in capital equipment for new production lines for making organic LED screens in Asia accounted for this hike, and helped to drive up Riber’s year-over-year revenue by 40 percent to €29.0 million. Profit also jumped, rising from €1.8 million in 2010 to €4.3 million in 2011.

At the end of March, the company recorded quarterly revenue of €6.2 million, up 8 percent compared to the same quarter of 2011. During those 12 months the order book fell by €1.8 million to €19.5 million, which included requests for shipments of 13 research systems and one production machine by the end of next year.

The weakening order book results from a contraction in orders of cells and sources for OLED production. However, Riber is now preparing a new generation of cells to catch the next wave of investment in this industry.

Teleco woes

Propping up this year’s table is US-headquartered Oclaro, which was formed in 2009 through the merger of telecom component makers Bookham and Avanex. Back in March 2011 Oclaro’s shares hit $18, the high-point since the merger, but they plummeted throughout that summer, and are now worth less than $3.

Oclaro posted weak quarterly figures during that period of falling share value. Revenue for the fourth fiscal quarter 2011 that finished on 28 July 2011 was $109.2 million, down $6.5 million quarter-over-quarter, and more worrying, operating loss rocketed from $6.6 million to $33.6 million (however, the latter did include $20 million of impairment charges). The company blamed an extended slowdown in the telecom sector for the poor figures. Three months on, revenue had fallen to $105.8 million, in line with previous guidance, losses were reduced to $9.6 million, but production in Thailand had been halted due to flooding.

This flooding impacted second quarter 2012 revenue, which fell to $86.5 million, and contributed to high operating losses – $33.6 million, which includes $9.1 million of flood-related write-offs.

The impact of the floods also made an impact on the most recent quarterly earnings, which were announced on April 26. Sales had risen slightly quarter-over-quarter to $88.7 million, and could have been about $4 million higher still, if it had not been for a 10 day stoppage at the Shenzhen factory, which has subsequently been resolved. Oclaro is trying to sell this factory, and is planning to move production from this site to Malaysia, where it believes there is a much more stable manufacturing environment.

Another, bigger change for Oclaro will be its merger with Opnext. Oclaro’s chairman and CEO Alain Couder believes that this move will be welcomed by customers, who want to work with fewer, more strategic suppliers who can deliver the breadth of technologies they need.  

“Through this merger, [Oclaro’s and Opnext’s] complementary and vertically-integrated product portfolios, scale, and heritage of technology innovation will put the merged company in that valued strategic partner and leadership role."

The merger should position the new company as the second biggest player in the optical components and modules market, behind Finisar. But can this marriage can halt the declining share prices of both companies, and create a profitable enterprise? Time will tell, and the result should be evident on next year’s leader board, which will hopefully show that III-V shares have lost that sinking feeling.

Disclaimer. Richard Stevenson holds a small number of shares in IQE



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