The case for INFN

Investment Analysis Clubs Saul’s Investing Discussions
#1

I think many people are overlooking Infinera. They either think the company is a dog, looking backwards, or that it is overvalued, looking at the P/E on google or yahoo, or think it is a commoditized product that is in a cyclical industry. Which is true. But why do I think that Infinera could be a great investment at this time?

First, Lets look at the P/E. Infinera today is around 20.31 which gives it a P/E of 39.82. While that is high when just looking at the P/E its low compared to its growth. It grew EPS at 325% YoY and its last quarter EPS was a blow out with an earnings of $.16 Q1 15 and $.03 in Q1 2014. That is a growth of 533% (These are all Non-Gaap numbers / adjusted). Its 1Ypeg is at .12.

Secondly its a dog. If you had followed this company since 2009 that thinking would have been understandable. They had a lot to prove. They jumped from the 10gig market directly to the 100 gig market, skipping the 40 gig market. While this hurt them from 2009 to 20014 there decision came to be really solid. They are now leading the charge in the 100 gig long haul market and in the middle of the growth cycle for the 100 gig long haul market. They are starting to provide more blades into that market which is causing their margins to expand. But that isn’t the end. They now have entered the Metro Market, and are in the process of buying Transmode which will give them more products for the metro aggregation market. They also have a product for the Cloud called Cloud Express and they are partnering with Anet in the Data centers. They were recently named Ovums number one pick for Internet Content Providers. The Data Center cloud market is expected to reach 2.4 billion by 2019.
http://investors.infinera.com/phoenix.zhtml?c=209747&p=i…
The Data Center Interconnection market is expected to reach 4 billion by 2019 and they will be moving into the Metro aggregation market in 2016. This company still has years to grow.

Finally, Yes this is a cyclical industry but the growth can be tremendous while it is going on. The data just keeps growing and this just keeps pushing Infinera’s Revenues. There will come a time where you will want out of this company but with Infn finally pushing into the Metro market this will be years away. I suspect we will see good growth at least till 2020. It bears watching to see if earnings or/and Revenue starts to decrease but that time is not now.

Infn. Q1 15 eps .16 Q1 14 eps .03 TTM EPS .51/.12 1YPEG.12

Andy

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#2

(brief appearance out of lurkerhood here)

For those who subscribe to any of the TMF subscription services, see if (one of) yours recommends INFN. If it doesn’t, I might recommend getting one that does. (Odds are an investment in INFN will more than cover the subscription fee.) Then, on its INFN board, read FoolishErik’s multi-chapter description of the company, its technology, and its markets. It is FANTASTIC, to a Poster-of-the-Year degree, and exemplifies what’s so great about the Fool. I don’t know that I’ve ever seen anyone, even TMF writers, put in so much effort just in the interest of helping part of the Foolish community understand their investment. I feel almost guilty just thinking about the hours he must have spent researching and writing those pieces, considering how much they helped me de-mystify INFN.

awiseowl

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#3

Andy, a low PEG is only cheap if the growth is sustainable. Given that it’s a cyclical, as you say, how long will that growth be maintained? It sounds like they’re basically coming off the bottom of the cycle, and so the relative growth will look huge.

Or maybe asked another way, what do you think is realistic for average annualized EPS growth over the next 3 years?

And then I guess the other thing with a cyclical, is that presumably everyone knows that it’s a cyclical and will be trying to get out before the cycle turns. So how do you manage that? Sounds stressful to me :wink:

Neil

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#4

Andy, a low PEG is only cheap if the growth is sustainable. Given that it’s a cyclical, as you say, how long will that growth be maintained? It sounds like they’re basically coming off the bottom of the cycle, and so the relative growth will look huge.

Neil,
That is a true statement for any company. I realize you are worried this might be a value trap and for good reason. Nobody wants to be in a value trap but Infinera is only through about 1/2 the cycle in Long Haul and they still have the cloud and metro aggregation to work through. They are just starting the cloud, Data center, ramp up. We should see good growth out to at least 2020. Of course every quarter I do re-evaluate the company and at this point in time I see no reason to sell my investment.

Or maybe asked another way, what do you think is realistic for average annualized EPS growth over the next 3 years?

I have no idea Neil, nor do I want to predict it. A company growing this fast would be hard for anyone to predict what its EPS growth over the next 3 years will be. But I will say this. Analyst expect Optical transport to grow 7-10% over the next 3 years and Infinera says they will double that. Infinera has grown their Revenue over 30% the last two quarter and it has been accelerating since Q4 2013. Their Margins will start growing also since they already have equipment installed at the customer site and now they need to start filling the equipment up with blades.

And then I guess the other thing with a cyclical, is that presumably everyone knows that it’s a cyclical and will be trying to get out before the cycle turns. So how do you manage that? Sounds stressful to me :wink:

LOL ok Neil I do not want to stress you out but the stock Market is Cyclical also. :slight_smile: In reality I understand this market because I have been in it for 31 years. I worked for Nortel and say the rise and fall so believe me I have seen these companies go up and go down. They can be very profitable on the way up and completely devastating on the way down. But now that I work on the Metro side of the market I think I will have a heads up when the market starts getting a little long. Now isn’t that time because the fiber roll out is growing strong. Data is really growing and is going to keep growing with all the data being streamed. But you are right that we need to keep a watch when the cycle turns. This is not a long term buynhold but that doesn’t mean it can’t be profitable.

Andy
Long Infn

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#5

Folks,

I’ve been following INFN to some degree for several months and have been scanning the incredibly in depth Chapter posts mentioned upstream.

I’ve stayed away from INFN based on valuation, but not the valuation practiced on this board. It’s interesting to see the 1 YrPEG and growth rates. It is one of the stocks I tracked in my attempt at trying Saul’s charts electronically.

Regarding the company, I’ve been interested in their competitive position for some time. Their vertical integration has allowed them to protect trade secrets as they manufacture products in-house.

Based upon the Chapter posts, they are clearly the current leader in long haul data transport and have a good likelihood of transitioning to the metro market. More internet users gobbling up more data should equate to a steady need for their products.

Their technology is PIC (Photonic Integrated Circuits) which I believe nobody else is capable of currently.

I’m no expert and this is all from memory. I’m much more interested in this stock after seeing the 1 YrPEG and growth rates.

Scrutinize all info provided please. I’m newer at this than many of you and am interested in further feedback.

Lastly, on a negative note, I’ve heard they rely heavily on stock based compensation for their employees and would be interested to know if this is a concern.

Take care,
A.J.

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#6

Thanks, Andy, I found the Chapter posts and will read through them.

which gives it a P/E of 39.82

To be “fairly valued” using the PEG approach, that basically means we need to see sustained 40% annualized EPS growth out of Infinera. If they can only grow revenues by 30%, that implies margin expansion will be necessary.

You say that is likely to happen because they have higher margins on the incremental additions than on the initial hardware purchase (if I’m understanding you correctly). But I do have one question, and I apologize if this is addressed in those posts: presumably the company will want to prepare for the next cycle and will invest very heavily in R&D while it’s making money in this cycle. I personally have been burned in the past before with companies when they finally see success because they pour all their would-be income into R&D for the next cycle, destroying earnings. So what’s your thought on this? Is Infinera already well-prepared for what comes next, or do you foresee significant increased spending?

Ok, I’ll go read those posts now :wink: Sorry if these are dumb questions.

Thanks,
Neil

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#7

A.J,

Lastly, on a negative note, I’ve heard they rely heavily on stock based compensation for their employees and would be interested to know if this is a concern.

That is a good point. Their share based compensation comes in at 4% to 5% a year. According to Tom Engle this is a concern. I used to be really worried about it but then I believe Tom Gardner stated on one of his video’s, I believe I remember this correctly, that he doesn’t overly worry about it because who is he to tell someone what they are worth? At least that was the Gist of it. I see both points and when a company is doing bad it can really drag on the Stock Price but when a company is doing good everyone seems to forget it. So I note it when I am looking at a company, it is something I want to keep an eye on, but it doesn’t influence my whole judgment of a company. I see it as one more data point, like you said, on the negative side.

Andy

#8

Awiseowl,
You are right that was a fantastic write up and the hours Erik put into it was beyond belief. If anyone has access to RB they should look at it.

#9

Ok, I’ll go read those posts now :wink: Sorry if these are dumb questions.

Please Neil all of your posts are great and that is why I like these boards. We can discus an idea and see everything from all sides. I have been to lenient with some of the companies I have followed but with help on these boards I have been learning a lot and changing some of my viewpoints. So feel free to ask away.

I apologize my Math was completely incorrect. The Eps growth from Q1 2014 to Q1 2015 was actually 433% not 533%. It was a subtraction problem. But the Eps growth sequentially went up 23%.

To be “fairly valued” using the PEG approach, that basically means we need to see sustained 40% annualized EPS growth out of Infinera. If they can only grow revenues by 30%, that implies margin expansion will be necessary.

You say that is likely to happen because they have higher margins on the incremental additions than on the initial hardware purchase (if I’m understanding you correctly). But I do have one question, and I apologize if this is addressed in those posts: presumably the company will want to prepare for the next cycle and will invest very heavily in R&D while it’s making money in this cycle. I personally have been burned in the past before with companies when they finally see success because they pour all their would-be income into R&D for the next cycle, destroying earnings. So what’s your thought on this? Is Infinera already well-prepared for what comes next, or do you foresee significant increased spending?

All great points Neil. Lets start with the Higher margins. When the company first installs the equipment they have to pay Contractors to come in and place the equipment. This takes two guys about a week. Once the equipment is placed the cards can be added by the customer and deployed by Infinera’s Noc. That is why the margins increase because the cost of placing another Blade is very inexpensive for Infinera. The initial install keeps the margins down though. Also they have a service team that works on tech support and a feature with their 500 gig pics were the customer can request the service to be turned up incrementally. They can start at 100 gig and turn up another 100 gig at a time. Another thing that helps is that they are vertically integrated. Also in the Q1 conference call they mentioned again that they would be unveiling a new financial target with higher margins.

Neil great point on the R&D. They plan on keeping their R&D at 20% of Revenue. Right now they are ahead of the game. In the Optical transport world, they are the first with a optical switch. It doesn’t switch optically but electrically along the backplane but the 500 gig pic (that they are using now soon to be a terrabit) they can touch any client card in the chassis. This is not available by any other transport company. But they are going to keep R&D at 20% and the really great thing about their new DTN-X product, which just came out, is that they build it from the ground up. Their Pic technology allows them to put many photonic pieces onto one card. This is growing exponentially according to Moore’s law. This allows them also to bring out higher bandwidth chips faster than their competition. As we go along this is growing to only get harder for the competition to keep up.

Finally, one more thing on the R&D side, the Dtn-x technology is allowing them to go into the Data centers with their new Cloud Express equipment. Most people don’t realize it yet but the Data Centers are going to be huge growth, maybe even providing as big or bigger opportunities than the Tier 1 companies. These Data Centers are very profitable and they want the best equipment. Now Infinera has partnered with Anet, but Anet has partnered with ALU also. Anet is going through a lawsuit with Cisco and Cisco as I write this is trying to use the courts to block Anet from selling their equipment into the U.S… While Anet is an American company they have their product produced overseas. This is just my thought so don’t take it as gospel but since INFN is vertically integrated and produces all their products in the U.S, if ANET loses their lawsuit to Cisco it would make send for them to merge with INFN and have their equipment made in the U.S… But I digress.

Neil I see their R&D as strong and I think they can stay on top with their R&D spend at where it is at now.

Ok, I’ll go read those posts now :wink:

It would be really smart to read those posts, they were well done and enormously enlightening. I hope I wasn’t abrasive in any way, I just want to give something back for everything you all have done for me.

Andy

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#10

One more thing I am long Infn and Anet now.

Andy

#11

Neil,

Your posts are solid additions to this board.

I appreciate your thoroughness in researching companies, your incredible hard work for all of us on this board, and your gracious humility.

Many thanks from West Texas!!!

Jim

3 Likes
#12

You are right that was a fantastic write up and the hours Erik put into it was beyond belief. If anyone has access to RB they should look at it.

He cross-posted to HG as well.

We all owe FoolishErik a beer. Or as many beers as he wants. We need to keep him in beer for life, basically. The effort he expended just for the benefit of his fellow Fools is mind-boggling.

#13

I bought 7/19/13 and am up tidy 61%. Thanks for the reminder to check up on it and consider increasing my position.

I have to say, I have read up on the company but the engineering is beyond me. I just do not have the background. But it is easy enough to keep an eye on revenues and earnings. I hope that they are widely adopted if only to get my Netflix streaming smoothly!

I am required to remind you that you can see all my holdings on my profile. http://my.fool.com/profile/TMFFlygal/info.aspx but you knew that, right?

Supernaut, Flygal

#14

Hi Flygal,

I have to say, I have read up on the company but the engineering is beyond me. I just do not have the background. But it is easy enough to keep an eye on revenues and earnings. I hope that they are widely adopted if only to get my Netflix streaming smoothly!

I think people’s eyes can gloss over looking into these companies :slight_smile:

Keep an eye on TMFDatabaseBob’s posts. He does a really great job on the quarterly conference calls.

Andy

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#15

Thanks :slight_smile: for the pain… I used to own INFN. Sold a little of it 1/22/14 and the bulk on 7/19/14. 1000 shares! Was tired of waiting for 100’s to sell to bigger users. Don’t know if a “Saul” analysis would have prevented this decision. Maybe I’ll go back and look, maybe just move on. Also, not sure what I bought to replace. Maybe don’t want to know :slight_smile:

KC

#16

I had mentioned before, a time or three, that I held a full position in INFN. I began buying INFN in November through December, 2014. Share price varied between $14/15. The share price was on an upswing. Color me happy. Then…a funny thing happened. In late April, I began seeing notices of heavy insider selling. I did some research. True enough, several insiders were selling a significant number of shares in the $18/19 range.

Just to be clear, I’m not one to pay much heed to insider sales (significant insider buys ALWAYS tweak my interest). What was happening with the INFN insider trades was that several key insiders were selling significant majorities of their shares. WTF!?! Granted, I get that INFN is overly generous with stock options. Many option grants have since been doled out in May. What I didn’t get (still don’t) is why insiders would sell so many of their shares if the company was on the cusp of significant growth? I don’t get it. Still don’t get it after rooting around the Interwebs for many hours/days on end.

Bottom line? I harvested some profits, selling shares ~$19. Roughly a 30% return in just 6 months. I kept half my position…hoping for the best…trying to understand.

Here’s the long and short of it: The share price appreciated > 100% in just 52-weeks. Today, short interest hovers around 10% and analyst opinions are all over the map from outright SELL! to outright BUY!

This one’s a bit tricksy.

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#17

Then…a funny thing happened. In late April, I began seeing notices of heavy insider selling (of INFN). I did some research. True enough, several insiders were selling a significant number of shares in the $18/19 range. Just to be clear, I’m not one to pay much heed to insider sales (significant insider buys ALWAYS tweak my interest). What was happening with the INFN insider trades was that several key insiders were selling significant majorities of their shares. WTF!?!

Hi Putnid, Funny thing! On April 16, after a long and extensive debate (which they published), Supernova sold a third of their position in AMBA! Why? You’ll never guess! Mostly because the insiders sold a lot of their shares. Really a lot.

The price of AMBA on April 16, when Supernova sold, closed at $74.60. Most of the insiders sold for less. It closed yesterday (about six weeks later), at about $87.20 !!! . Insiders are usually better at running their companies than managing their investments. Just sayin…

Saul

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