Below is part 2 of my "progress report” that attempts to summarize Infinera’s first quarter. Part 2 will focus on Long Haul and Subsea. Like the first part covering DCI, much of the detail behind the summary was taken from various former posts and explorations.
Long Haul / Subsea
Key metrics for the product segment:
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Infinera agrees with the prevailing market research on Long Haul growing at 6-7% in 2016.
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Their estimated TAM in this segment is approximately $5.2B for 2016. Their TAM in 2015 was $4.8B. They estimate a CAGR of 5.4% from 2015 through 2019 - or $6B in TAM by the end of 2019.
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Infinera’s DTN-X accounts for over 30% of total 100G wavelengths deployed in the long haul market, worldwide.
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This segment accounts for the bulk of their business (I rough it at over 75%). For comparison, DCI accounts for about 5-6% of their business while Metro is currently around 15-17% (they have said it is under 20%)
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This part of their business is in ultra high margin mode. Contributions from this segment are fueling investments as they continue to ramp up their presence in DCI and metro markets.
Key observations:
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Although this part of the market is expected to grow at 6-7%, Infinera expects to outgrow the market. Here are their indicators:
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Aggressive deployment in the 100-gig long-haul footprint over the past few years leading to a higher margin business at this stage through bandwidth activations (at 100% margin) and line card additions (at >50% margin)
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A track record of supplying 48% of the 10G wavelengths when the market was focused on 10G
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New purpose-built products to address additional markets: DTN-X XT-500, a Long Haul point-to-point interconnect that fits in a rack, and an XTC-2 series, a smaller version of their larger DTN-X devices for slightly shorter reach markets
Expectations for Q1:
As far as what to expect from Long Haul in Q1, here are their public updates since the last earnings call
The big takeway at PTC 2016: Several of Infinera’s customers in the subsea market are actually seeing 40% YoY growth in long haul bandwidth this year (https://www.infinera.com/videos-cpt/big-take-away-ptc/). This is substantially higher than the 6-7% market average, and provides some evidence of Infinera outgrowing in the Long Haul market through their subsea sales.
High-performance networks in Research and Education are keen on Infinera: "GARR, the Italian Research & Education Network, has deployed the Infinera DTN-X XTC Series to deliver advanced services and increase network efficiency as GARR scales its network capacity.” GEANT was another advanced research network with an update, but in Cloud Xpress.
Some additional points of reflection:
This is my opinion, but I believe Infinera is quietly taking over the enterprise & wholesale market. They’ve stated their growing position on the past two conference calls, and recently called it out as an area being overlooked by the analysts: "I think an area that’s often missed by analysts is how much wholesale and enterprise carriers are carrying internet content by content, it’s staggering and I said on the call that our business with that market doubled last year.”
For further evidence of their growing position, take a peek at the ITW 2016 conference coming up. The ITW (International Telecoms Week) is "the world’s largest meeting for the global wholesale telecommunications community.” The sponsor list is here: http://www.internationaltelecomsweek.com/AboutOurSponsors.ht…. The list reads like a who’s who in the world of wholesale telecom and enterprise reality - quite impressive. Notice the only system vendor on that list.
Concluding remarks:
From an overall market perspective, Long Haul appears to be maturing. However, Infinera looks well positioned to outpace the growth of this market as a result of their business model. As bandwidth demand grows in this segment, so too will margin contributions from their long haul product line via Instant Bandwidth and additional line cards. If Infinera stopped here they’d well north of a 50% margin business, and likely nearer to the 65-80% neighborhood.
Thoughts on the recent board conversations over P/E:
I also believe the market is awarding Infinera very little in the form of P/E multiple for the segments they are getting into. DCI was one of the two emerging markets that should have cut them some slack on a higher P/E. Here there were early success demonstrated, but the stock price came down over concerns raised on alternative solutions. Those concerns have since been largely refuted, but unfortunately their business is not an easy one to understand and I believe the market is showing their caution and misgivings. The repeated slam over the same issue from different journalists did not help with public perception. Only time will tell who is correct. After investigating the issue thoroughly I believe this is one misunderstanding made by the public that is resulting in a pricing error.
Metro is the second new market area for Infinera and I will get into that portion in the next write up. However, I do want to queue up one thing: This is the area of biggest risk for Infinera. One can argue DCI was practically a space Infinera helped define (and thus was theirs to lose), but the Metro market has been around for years. I believe this is the biggest area of concern for investors. Simply, there hasn’t been evidence of the large Metro deployment needed to take share in this market (a market size that will rival long haul). We have hints at RFPs coming - but no indication of their size, shape or impact, nor are they offering guidance on how analysts should model Infinera’s portion of the opportunity. We do, however, have one thing to help us. Ciena guided below the market growth rate for Metro on a recent earnings call. That caused their stock to tank (and Infinera along with it) - but no one asked if this was a demand issue for the market overall, or a demand for their products specifically. Later in the year component manufacturers provided their reports and indicated otherwise - that demand was still quite strong. Infinera has not risen up yet as a result. They’re still on the same path and trajectory as Ciena. On the call on Wednesday we’ll hopefully get more of a direct indication of those RFP sizes from Infinera. If those RFPs are not all landing on Ciena they’ve got to be landing somewhere. Hopefully we’ll see some of them find their way to Infinera. Once we have a solid indication of this market picking up for Infinera, I believe the P/E multiple will rise back up, but it may take another quarter or two to fully get that evidence. Otherwise, if they don’t make traction in Metro I would have to concede with Saul’s assessment that this stock will be forever in the 17-20 P/E range as he suggested. I remain optimistic.
Best,
–Kevin