Why 2017 Was a Year to Forget for Infinera Corporation

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Infinera (NASDAQ: INFN) shares fell nearly 20% this year, disappointing investors who considered the optical transport networking service a good way to play the "super cycle" in fiber upgrades. The bulls believed that the rising use of streaming media, cloud services, and other data-intensive tasks would boost demand for optical components and services worldwide.

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Unfortunately, several headwinds derailed that thesis over the past year. Let's take a look at the main problems, and whether or not Infinera will overcome them next year.

Exposed to the "wrong" fiber market

Infinera generates most of its revenue from long-haul WDM (wave division multiplexing) systems, which help carriers expand the capacity of their long-distance networks without laying down additional fiber. Infinera accomplishes this by sharing (multiplexing) a large number of optical signals across a single fiber with different wavelengths of light.

Infinera generates less revenue from its newer metro and DCI (data center interconnect) services, which accomplish similar tasks over shorter distances. The big problem for Infinera is that demand for long-haul WDM services has been sluggish over the past year as service providers invested more heavily in shorter-range metro and DCI connections.

That cyclical shift caused Infinera to post four straight quarters of double-digit sales declines before posting 4% growth last quarter on warmer demand for its newer ICE4 products. Infinera expects long-haul WDM demand to rebound in the second half of fiscal 2017, but the recovery could still be sluggish.

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Plunging orders from its key markets

This slowdown hit nearly all of Infinera's markets. During the first nine months of 2017, revenue from its biggest market, the United States (60% of sales), dropped 27% annually. That drop was attributed to long haul challenges, weaker orders from CenturyLink (NYSE: CTL), and weak orders at an unnamed large ICP customer.

Revenue at Infinera's second largest market -- Europe, the Middle East, and Africa -- dropped 7% and accounted for 30% of Infinera's top line. But on the bright side, revenues from both markets rose annually last quarter, indicating that a cyclical turnaround might finally be around the corner.

Limited exposure to Asia

Research firm The Insight Partners expects the global optical fiber market to grow at a CAGR (compound annual growth rate) of 11.7% between 2016 and 2025 to $27.9 billion. China is the industry's largest market and accounts for over half of all optical fiber orders worldwide according to Research and Markets.

Therefore, the "super cycle" bull thesis relies heavily on the growth of the Chinese market. Unfortunately, many network operators across China have been cutting their capex over the past year, throttling demand for fiber components and services.

China remains a promising long-term market, but Infinera's exposure to China and the Asia Pacific remains low relative to its other regions. Infinera's Asia Pacific revenue (7.5% of its top line) rose 15% in the first nine months of fiscal 2017, but that growth couldn't offset Infinera's aforementioned slowdowns across other key markets.

Better choices on the market

Lastly, Infinera suffered from poor comparisons to more diversified fiber players like Lumentum (NASDAQ: LITE), which is a major datacom supplier for Chinese telecom equipment giant Huawei.

In addition to its strong core fiber components business, Lumentum owns a secondary business of industrial lasers, which offsets the cyclical volatility in fiber demand. That's why Lumentum outperformed most of its industry peers this year with a near-40% rally.

But are there brighter days ahead?

2017 was clearly a year to forget for Infinera, but 2018 could be much better. Analysts expect Infinera's revenue to drop 16% this year, but rebound 8% next year as the long-haul WDM market recovers and its smaller metro and DCI businesses gain momentum. One of its new DCI customers is Netflix (NASDAQ: NFLX), which is deploying Infinera's Cloud Xpress 2 DCI solution to boost its streaming capacity.

Infinera is expected to post a net loss this year, but that loss should narrow next year as its revenue accelerates and a recently introduced restructuring plan -- which is aimed at cutting annual costs by about $40 million -- kicks in. Therefore, it's highly likely that Infinera's stock has hit a cyclical bottom, and could rally over the next few quarters.

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