Investors Bet Big Against Acacia Communications -- Here's Why They're Wrong

By Leo Sun Markets Fool.com

Acacia Communications (NASDAQ: ACIA)has taken investors on a rollercoaster ride over the past year. Shares of the fiber-optic products company soared from the IPO offer price of $23 per share to over $120 between May and September, before plunging all the way back down to the $40 to $50 range.

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That decline attracted hordes of short-sellers. As of mid-April, 61% ofAcacia's shares were being shorted -- making it the most heavily shorted stock on the market. But if we take a closer look at the bear and bull cases for Acacia, we'll see that the stock's downside could be limited.

Image source: Getty Images.

What the bears believe

Acacia's revenue rose more than 100% annually during its first three quarters as a public company. That growth was attributed to rising demand for fiber-optic components across multiple industries to meet higher bandwidth demands for streaming video, data transfers, cloud-based apps, and other virtualization needs.

However, Acacia's sequential growth isn't as impressive. Revenue rose 16% sequentially in the third quarter, then 5% in the fourth quarter, and it's expected to fall 20% to 24% during the current period. Analysts had been expecting a 3.5% decline.

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Acacia blamed that abrupt slowdown on lower-than-expected orders from a major customer -- widely believed to be ADVA Optical Networking -- with exposure tothe data-center interconnect (DCI) market. That statement sparked concerns that demand from cloud andcontent provider clients could be dangerously unpredictable in an already cyclical market. In mid-April, fresh concerns about slowing orders from China -- a key pillar of the so-called fiber "super cycle" -- sank fiber stocks across the market.

Another concern about Acacia is its customer concentration. In fiscal 2016, itsfive largest customers -- which include ADVA and Chinese tech giant ZTE -- accounted for 78% of its revenue. Lower orders from any of these customers could shatter Acacia's top-line growth.

What the bulls believe

The bulls will probably argue that the bears overlook the technological significance of Acacia's products. Its coherent interconnect products help cloud infrastructure and service providers boost the capacity of existing networks across thelong-haulwave division multiplexing, metro, and DCI markets.

These solutions enable service providers to increase the capacity of their networks without laying down additional fiber. Demand for long-haul solutions, which cover longer distances of over 1,500 km, has been waning as service providers focus on shorter-range connections in the metro (under 1,500 km) and DCI markets.

Image source: Getty Images.

That shift hurts Acacia's rival,Infinera, which is heavily weighted toward long-haul solutions. Acacia, however, generates more revenue from the metro market, with a smaller percentage coming from DCI clients. Therefore, while reduced DCI revenue is certainly disappointing for Acacia, the strength of its metro business and a cyclical rebound in long-haul revenues could get its growth back on track.

Acacia also uses a smaller, denser, and more power-efficient 400G chipsets than Infinera, which the company claims are better optimized for new software defined networking (SDN) solutions. SDN solutions reduce the need for on-site networking hardware by transferring the workload to software and cloud-service providers.

That's why analysts believe that Acacia's revenue will still rise 19% this year and 20% next year. Its earnings are expected to grow 4% and 14%, respectively. Those figures indicate that Acacia won't fade away anytime soon. Furthermore, Acacia's current P/E of 15 times is much lower than the industry average of 30. Infinera, by comparison, trades with a negative P/E because of its inconsistent profitability.

Why the bears will be proven wrong

It's easy to spot the near-term headwinds for Acacia, but I doubt that they'll knock the entire company off course. Acacia has better exposure to short-range and SDN markets than do long-haul players like Infinera, and its 400G chipset widens its moat against potential rivals.

If we consider those factors alongside Acacia's positive growth forecasts and low valuations, we'll notice that it might be wiser to buy the stock at current prices than to short it. With over 60% of shares being shorted, all it could take is a positive headline or earnings beat to spark a brutal short squeeze.

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Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Infinera. The Motley Fool has a disclosure policy.