Infinera pricing inefficiency

Folks,

Based on the market close price of 14.98, the 1YPEG on Infinera is currently 0.19. This equates to a 19.5 adjusted P/E.

These are based on non-GAAP numbers. ($14.98 stock price divided by trailing twelve month earnings of .77 cents = 19.5).

A 19.5 P/E is near the lowest this stock has been over the past 2 years.

Giving credit to Neil’s 1YPEG site (http://www.1ypeg.com/INFN), here is where the historic P/E bands break down. The chart shows the % time the stock price has closed above a particular P/E band:


                     Historical Adjusted P/E Valuation Bands                       
+---------------------------------------------------------------------------------+
|  P/E   Percentage of Market Days that Closed Above P/E over Past 2.25 Years     |
+---------------------------------------------------------------------------------+
| 269.7+ #####  10%                                                               |
| 72.4+  ##########  20%                                                          |
| 55.2+  ################  30%                                                    |
| 46.6+  #####################  40%                                               |
| 43.2+  ##########################  50%                                          |
| 40.3+  ###############################  60%                                     |
| 37.5+  ###################################  70%                                 |
| 31.5+  #########################################  80%                           |
| 21.3+  ##############################################  90%                      |
| 19.1+  ##################################################  99%                  |
+---------------------------------------------------------------------------------+

At its median, the stock was awarded an adjusted P/E multiple of 43.2.

Going back to recent lows, the stock was awarded a P/E of 19.1. This was on February 18, the lowest its ever been.

If the medium P/E multiple from the prior two years was assigned today the stock price would be $33.26 instead of $14.98.

Clearly, the market is not giving Infinera credit for any of its recent earnings reports, and as a result we have the the lowest valuation the stock has seen.

To me, this seems to be a pricing error - a market price mismatch given where we are at in current bandwidth demand cycle.

The question posed: why doesn’t the market also see this?

There have been a couple of theories. First, the Transmode share holders. The theory there is most shareholders after an M&A tend to dispose of their shares over the following year. This would have added selling pressure. Then, we have institutional brokerages affecting the stock price through sell recommendations. The theory there is to influence pricing levels so that institutional buyers can acquire shares at lower prices - ahead of the forecasted demand cycle. We also have convertible bond holders with coupons that mature in 2018. When these bonds exchange hands the acquirer (usually a hedge fund company) will short the stock at the same time to protect their investment and to take advantage of pricing mismatches between the stock price the bond’s price. All these things likely contributed to the last 6 months worth of selling pressure.

In the very near term we also have Infinera’s guide for next quarter. On this front Infinera has guided their EPS and revenue down sequentially QoQ (but remain up by 30% YoY). The sequential guide down was because they are beginning to participate in the broader market’s seasonality as they start to grow bigger. But, while competitors have guided down sequentially QoQ into the teens, Infinera is guiding down in the single digits. So while the guide is down, it is down by about half as much as their competitors.

On top of the selling pressure just mentioned, I also think the market is perhaps focused intently on this fact: the guide is down. There may be more ado on this coming quarter without looking much further.

Still, if we model just what we have in the coming quarter - and we assume they match earnings and revenue at the upper end of guidance (they have historically beat their own guidance range so this is a conservative assumption), we’ll have the following revenue growth projection (again, courtesy of Neil’s 1YPEG tool):


                             Revenue - Historical and Projected Stats
+---------------------------------------------------------------------------------+
| Fiscal Q.      Revenue    TTM Revenue     YoY TTM Growth    Growth Acceleration |
+---------------------------------------------------------------------------------+
| Q1 2016          $250M          $951M              33.4%                   1.8% |
| Q4 2015          $260M          $888M              32.8%                   5.5% |
| Q3 2015          $233M          $814M              31.1%                  11.1% |
| Q2 2015          $207M          $754M              28.0%                   4.9% |
| Q1 2015          $187M          $712M              26.7%                  17.1% |
| Q4 2014          $186M          $668M              22.8%                        |
| Q3 2014          $174M          $621M                                           |
| Q2 2014          $165M          $589M                                           |
| Q1 2014          $143M          $562M                                           |
| Q4 2013          $139M          $544M                                           |
| Q3 2013          $142M                                                          |
| Q2 2013          $138M                                                          |
| Q1 2013          $125M                                                          |
+---------------------------------------------------------------------------------+

So, if Infinera just manages to report at the top end we’ll have 33.4% revenue growth - a growth that is still appreciating nicely. Is that worth a near historical low P/E of 19.5? Keep in mind, very little of the metro business is reflected in today’s revenues. Metro is expected to be a big contributor in the second half. DCI is also expected to continue its ramp. And Long-haul/subsea is also going to grow.

DCI is not a 20% business, yet. It is still in its infancy. Metro is not a 20% business, yet. Expect that to take off in the 2nd half and continue to accelerate in 2017 and 2018. Very little of the new market contributors are reflected in the revenue growth trajectory we are on today. It is all predominately based on their long-haul business. A very nice business at that.

Infinera’s total addressable market has doubled (and then some) and no one is giving Infinera credit for admission. That’s the pricing inefficiency we have today, and that’s the opportunity.

What’s the downside risk? If we assume no penetration in any of the other markets Infinera would still be in a very good business. In fact, EPS would skyrocket since they’d be in a mostly high-margin mode of operation with their legacy deployments in subsea/longhaul which sees bandwidth growth of about 20% a year. Frankly, I don’t see much downside risk at these levels, at all. In my view we’re at historic lows - the best time period to buy the stock at pricing levels we’ll most likely never see again. My opinion of course.

Best,
–Kevin

40 Likes

Hi Kevin, As you know, I like INFN a lot too, and it varies between my 4th and 5th biggest position depending on the day, but I think you are overlooking something. It could be that the reason the PE was always higher in the past is partly because in the past they went for a long time without much in the way of earnings, and they were trading on dreams for the future. For example, I look back at 2013 and they had adjusted earnings of just 3 cents, so they would necessarily have an enormous PE. Now they have become real, and maybe they are having a more real PE (although I agree it’s low for a company with their rate of growth and prospects).

Saul

22 Likes

I agree with you Saul they went a very long time without any earnings so I do not think historical earnings is a very good way to look at INFN. Also I think the stock based compensation keeps the stock price down. They have historically had a very high stock based compensation. But recently with the higher Revenues this is coming down and is now down below 4%.

Andy

4 Likes

You make it hard not to want to go overweight on INFN, Kevin.

2 Likes

If we all buy more, the price goes up, right? :slight_smile: