Is Infinera Corporation a Buy?

Infinera (NASDAQ: INFN) took investors on a roller-coaster ride this year, rallying nearly 40% in the first two months of the year before giving up all those gains and ending up down 15% for the year. The optical transport solutions provider was previously seen as a good play on the fiber "super cycle," with streaming media, cloud storage, and other data-intensive tasks encouraging widespread upgrades among service providers.

Unfortunately, poor revenue growth and four straight quarters of unprofitability cast serious doubts on that bullish thesis. Will things improve through the end of the year, or will they get worse? Let's compare the bear and bull cases to see if Infinera is worth buying.

The bear case against Infinera

Infinera generates most of its revenue from long-haul WDM (wave division multiplexing) and subsea optical transmission systems, which enable carriers to expand the capacity of their networks over long distances without laying down additional fiber. This is accomplished by "multiplexing" (sharing) a large number of optical signals on a single fiber with different wavelengths of light.

In theory, demand for this technology should be rising as telecom companies upgrade their long-distance networks. But, in reality, telcos are investing more heavily in shorter-range metro connections and DCI (data center interconnect) systems that link data centers to each other. Major telcos in the U.S. are also investing more heavily in expanding their digital content ecosystems instead of improving the capacity of their networks.

Infinera also offers metro and DCI solutions, but these newer businesses aren't generating enough revenue to offset its long-haul declines. That's why Infinera posted double-digit annual sales decreases for four straight quarters before finally rising 4% last quarter on decent demand for its newer ICE4 products.

Infinera expected the long-haul market to warm up in the second half of 2017, but the recovery will be slow, with analysts expecting 5% growth this quarter, a 16% dip this year, and 8% growth next year.

On the bottom line, however, Infinera remains unprofitable by both GAAP and non-GAAP measures, and its margins are contracting. During last quarter's conference call, CEO Thomas Fallon noted that "ongoing price aggression by certain competitors and technology transitions" are still driving prices down at a "rapid pace." Fallon believes that Infinera can return to non-GAAP profitability in fiscal 2018, but it could be very tough, since he expects the long-haul industry to generate "zero to 2%" growth next year.

Infinera seems cheap at 1.4 times sales, compared to the industry average of 1.9 for communication equipment providers. But its rival Ciena (NYSE: CIEN) -- which has a better diversified portfolio of networking solutions and is consistently profitable -- has a lower price-to-sales ratio of 1.3.

The bull case for Infinera

Infinera's headline numbers look lousy, but there are three reasons to be optimistic. First, it recently signed a deal with Netflix (NASDAQ: NFLX) to deploy its Cloud Xpress 2 DCI solution to boost its streaming capacity -- which would diversify its top line away from the sluggish long-haul business.

Second, Infinera recently announced a restructuring plan to cut annual costs by about $40 million. It plans to reduce its head count, close a remote research and development facility, and "rationalize certain products and programs."

Lastly, a Securities and Exchange Commission filing reveals that Fallon recently purchased 100,000 shares of Infinera at $6.33 -- just pennies above its 52-week low of $6.27. That purchase, which boosts Fallon's stake to 1.3 million shares, indicates that the stock could finally be near a cyclical bottom.

Is Infinera a buy?

Back in July, I warned investors that Infinera wasn't a reliable play on the fiber market. I'm less bearish on Infinera today -- since its sales are recovering and it's clawing back toward profitability -- but the fierce competition and sluggish long-haul market should still limit its upside potential 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.