Apple Plays Dirty With Finisar Investment That May Limit Competitors' Supply

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Apple (NASDAQ: AAPL) announced last week that it would give Finisar Corp (NASDAQ: FNSR) $390 million over time to build a new 700,000-square-foot manufacturing plant in Sherman, Texas. But that's only part of the story.

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Finisar is important to Apple because it makes the vertical-cavity surface-emitting lasers (VCSELs) that Apple uses in the iPhone X face-scanning technology, the Animoji feature, and the portrait selfie mode.

In order to keep up with demand for the iPhone X, as well as to add similar technology into future devices, Apple needs Finisar to be making more VCSELs because there aren't many suppliers in the field. In the 2017 fiscal fourth quarter, Apple said it bought 10 times more VCSEL wafers than were made worldwide "over a similar time period."

Apple has invested in other suppliers, including iPhone glass maker Corning, so this isn't an unusual investment for the tech giant. In addition, this investment is part of Apple's $1 billion Advanced Manufacturing Fund that it's promised to invest in U.S. tech manufacturing companies.

So what other reason could Apple have for investing in Finisar besides a feel-good marketing strategy of supporting U.S. tech manufacturers?

Apple plays dirty with its competitors

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As the artificial-reality market grows, other smartphone makers like Samsung and Huawei are looking for companies like Finisar to help supply the right components.

By investing in Finisar, Apple is trying to secure its place as a friend of the company in the hopes that it can limit its competitors' supply of AR components, said Gene Munster, managing partner at Loup Ventures, which provides capital to emerging technology start-ups. In addition, the components will most likely be more expensive for Apple's competitors and they will have to wait longer to get their orders fulfilled, he added.

"It's powerful chess game playing by Apple," Munster said.

During Finisar's latest earnings call, in early December, management alluded to the tight VCSELs supply. "We're producing as fast as we can and shipping everything we can make," Finisar CEO Jerry Rawls told analysts about VCSELs. Rawls added that nondisclosure obligations prevented him from specifying who was buying VCSELs from the company.

The new lab in Texas should be open in the second half of 2018 and will help Finisar keep up with the demand from Apple and other companies. For the past quarter, the company's revenue from VCSEL components was only in the "low single-digit millions" of dollars.

When an analyst asked why the company is willing to invest more than $100 million on just the equipment for the new VCSEL lab when the technology is still in the "nascent" stage, management replied that it had reason to believe demand would continue to surge.

"We obviously have some confidence based on our interactions with a variety of customers in both consumer and automotive [markets] that this is going to be a very important space for us," Finisar CFO Kurt Adzema said. "We feel very good about our relative position in this space, and that's why we're making the investment."

The market for 3D sensing is "gigantic," with most customers coming from the consumer and automotive space, Rawls said. And there's really only one other name in the 3D-sensor space, Lumentum Holdings, which Apple also does business with. Therefore, even with a new building filled with $100 million worth of new equipment, Finisar probably still won't be able to keep up with the demand, Rawls claimed.

These comments provide some insight into why Apple might have felt it was a smart time to invest $390 million in a relatively unknown company like Finisar. Apple is getting into bed with the major VCSELs supplier right as demand is set to explode so much so that other customers are going to have to wait in line for 3D sensors and push off their product-release dates as a result.

But now for Apple, that probably won't be the case.

It's about the technology, and it's about defense

The Finisar investment clearly has a defensive edge to it as Apple looks to gain the upper hand on other smartphone makers and ensure that it won't have to wait in line for its components.

However, Apple is also obviously trying to secure its place as a leader in AR advancements. This investment is essential to Apple's future hardware. If Apple wants to keep its millions of iPhone users, then it needs to make sure customers feel that the products they're paying a premium price for are worth it due to cutting-edge technology.

Long story short, the 3D-sensor market is on fire right now, and Apple is paying attention.

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Natalie Walters has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Corning. The Motley Fool has a disclosure policy.