How Did Microsoft Corporation Sink Infinera Corp. Stock?

What Microsoft saidYet during the OFC conference, Microsoft unexpectedly declared its preference for "short-reach" (less than80km) data center DCI modules which are built directly into Ethernet switches, instead of stand-alone DCI systems like Infinera's Cloud Xpress and Ciena's Waveserver. Furthermore, Microsoft unveiled a new module co-developed with Inphi which plugs directly into data center switches, completely eliminating the need for dedicated DCI boxes.

That was bad news for Infinera, which had expected Cloud Xpress to become a major source of revenue as major web and cloud service providers upgraded their data center infrastructures. Last quarter, the company claimed that it had20 Cloud Xpress invoice customers, including a "number" of big Internet firms. Unfortunately for Infinera, it doesn't look like Microsoft will join that list.

Infinera's Cloud Xpress. Source: Infinera.

Microsoft's declaration was also bad news for Ciena's Waveserver, but a large percentage of Ciena's sales actually come from packet-optical systems which add short-reach DCI functions to Ethernet switches. Based on Ciena's subsequent rally, investors apparently believe that growth will offset any softness in its stand-alone DCI system sales.

Was Infinera unfairly sold off?Infinera shares fell as much as 10% on March 22 after Microsoft's announcement, but the stock has since recovered some of those losses. JPMorgan analyst Rod Hall calls the pullback a buying opportunity, claiming that the range of "direct detection" technology still remains too short and will eventually require dedicated DCI boxes.

Jefferies analyst George Notter admitted that the partnership between Microsoft and Inphi "sounds scary" for Infinera's DCI business, but noted that it will take some time for Microsoft and Inphi's short-reach solution to reach 80km distances. Notter believes that the shift might cause Infinera's Metro DCI business to lose $20 million in fiscal 2016, which would account for just 2% of its projected revenue. Notter also points out that both Infinera and Ciena still have growing customer lists of stand-alone DCI customers.

Last quarter, Infinera's non-GAAP revenue surged 40% annually to $260.6 million and beat estimates by $1.8 million. Product revenue rose 43% annually to $227 million, thanks to the acquisition of Swedish optical networking hardware firm Transmode, while services revenue climbed 19% to $33 million. Non-GAAP earnings per share rose 62% to $0.21 per share, topping expectations by a penny. Those numbers indicate that demand for the company's optical transport networking equipment and services remains robust. Moreover, analysts still expect Infinera's earnings to grow 15% annually over the next five years.

The valuations and the verdictDespite those positive numbers, I think investors should stay away from Infinera, which could be crippled by a tectonic shift in technological tastes among the major cloud providers. Considering that Microsoft is the second largest public cloud provider in the world after Amazon, investors shouldn't ignore the possibility of other cloud giants following Microsoft's lead. If that happens, short-reach DCI players like Inphi and Ciena could post stronger growth than Infinera, which might be placing too much faith in stand-alone DCI boxes.