What a year 2016 was for Infinera (NASDAQ: INFN) shareholders. The stock plunged over 50% last year, as its multiyear run of accelerating 20%-30% growth rates ground to a halt. The story changed from that of a high-growth technology company riding the secular trend of exploding data and bandwidth needs to one of stagnating revenues, profits turning to losses, increased competition, and end customers pausing investments in optical networks.
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The storm clouds seemed to part a bit recently, when the company reported Q4 earnings. Revenues beat both analyst expectations and the company's guidance, suggesting the worst headwinds for the company could be behind it. Infinera's stock surged almost 30% the next day, which no doubt allowed shareholders to breathe a sigh of relief.
Still, the $181 million in Q4 revenues was a far cry from the previous year's mark of $260 million, and the company still put up a loss for the quarter, reporting a GAAP net loss of $36.3 million. The stock is still 50% below its 2015 highs, and has a long way to go in order to achieve those levels again.
With a volatile end market and changed competitive dynamic, investors interested in Infinera may wish to focus on one particular number: the average selling price (ASP) of its 100 gigabit-per-second integrated circuits. The 100G circuits are vitally important as long-haul and metro carriers are upgrading to this standard from 10G faster than expected. According to Ovum Ethernet Services Forecast Report data supplied by Infinera, the 100G standard is set to outgrow 10G deployments over the next five years by a factor of 3-4 times, surpassing total 10G deployments by 2018.
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Infinera has said that, according to the Dell'Oro group, a research firm that tracks the telecom and networking markets, the ASP of these photonic integrated circuits (PICs) that Infinera sells fell by 29% in 2016. This led to a fierce drop in gross margins to 41.8% in Q4 2016, far below the 48.3% figure the company printed in the year-ago quarter.
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The company sells these circuits to an array of tier 1 telcos, cable providers, cloud companies, and internet content providers worldwide -- basically any business that needs to super-charge the bandwidth on either their own optical networks, or their connections to such networks (which is basically everyone at this point).
The reasons for the price drop could be a number of things, including increased competition, notably from Ciena(NYSE: CIEN). This was noted by CEO Thomas Fallon who, in the recent conference call, noted competitors may be trying to "buy" market share:
29%, that's fairly unprecedented. And it's not like there's a new technology that's hitting the market that causes that drop. There is a substantive amount of pricing pressure that's occurring. I do think it starts mitigating, but I think that there is a level of certain competitors who are willing to buy market share whether they can make money at it or not. That can't last forever, but I do anticipate pretty good pricing pressure.
Fallon clearly believes the company's competitors are acting in a way that is unsustainable long term. To that end, the company is stepping up its R&D investment despite the money-losing quarter, as management believes these investments will pay off with products that will allow it to regain its technology lead, and, therefore, higher ASPs. In the coming year, the company plans to release its new fourth-generation product family called the Infinite Capacity Engine. The company claims this new PIC will be the first 2.4 terabit-per-second transport technology , and Fallon believes it will technologically leap-frog the competition, leading to sunnier (and more profitable) days ahead.
Still, even with a successful launch, Fallon doesn't believe margin expansion will happen until the end of this year. Moreover, he said, "I do want to caveat it. When the market is in this type of transition with ASPs dropping that dramatically, [margin expansion is] hard to predict."
There is no doubt the market for optical networking hardware should continue to grow, as data and bandwidth needs explode globally. Still, investors hoping to ride the optical networking wave with Infinera should keep their eyes on those average selling prices as the year moves forward. Moreover, long-term investors will have to decide whether the company has any long-term advantages that will enable it to sustain healthy prices for its future products.
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