When I first wrote about
) back in 2007 (see
Infinera Corp.'s 'Yeah Baby' Moment
), the original title of the article was going to be "Infinera: You
Had Me at Photonic Integrated Circuit."
That's because, despite all the claims by other optical transport
equipment manufacturers, INFN was really the only one with a
solution that cut through the bottlenecks created when traffic
needs to jump on and off the optical network and is forced to go
through non-optical switches and other points of congestion.
While the technology behind such a solution was, and is, way over
my head, the logic behind an integrated, end-to-end transport
system was way too simple to ignore. So it is easy to see why INFN
IPO went off almost as well as its 10 GB solution was selling at
the time. Unfortunately, and not coincidentally, initial public
offerings do not tend to happen at the bottom of the cycle, but
rather the opposite. Combine that with the advent of the financial
crisis, and the rest of my thesis was effectively blown to bits in
a very short period of time. INFN business quickly entered what I
described on the
Buzz & Banter
(subscription required) as a "
." To prolong the drought, INFN made the strategic decision to
bypass the carriers' upgrades from 10 GB to 40 GB channels, and
focus all of its efforts on a 100 GB product, which in 2009 was so
far forward-looking to amount to little more than a leap of faith.
INFN in essence bet the farm that its 10 GB product and installed
base were going to be sufficient to carry it through several years
of development of a new state-of-the-art technology.
The consequences for the stock were pretty predictable. It has
traded between $5 and $10 for the better part of the last five
years, as investors where left guessing whether the 100 GB bet
would eventually pay off, or whether the company had missed the
boat for good. Early last year, management began talking up the
prospects for the new 100 GB DTN-X box even though the product was
still several quarters away from delivery, and there was still a
lot of uncertainty over carriers' acceptance (see
European Elections: At Full Speed Toward the Debt
Fortunately for the company, late last year it became apparent that
the 100 GB DTN-X box was indeed a winner, and the Q1 business
update pretty much confirmed that INFN is now staring at what
should be a
long and strong product cycle
Infinera Technology Advantages
To clarify the upside for INFN's business and its stock, I want to
touch on its key advantages vis-Ã -vis the
) of the world.
I have already mentioned the first technical advantage Infinera has
over its competitors: It provides a solution that can take packets
on and off optical transport networks without needing third-party
components to convert the signal from optical to electronic and
back to optical. In non-integrated solutions, the on/off point is
where the network traffic gets jammed.
Second, being an integrated system, carriers can add capacity to
their networks by simply adding line cards to their existing boxes.
This process does not require any time-consuming configuration and
can be accomplished in as little as 24 to 48 hours without any
disruption to existing traffic.
Third and most important, being a seamless integrated solution, the
DTN-X lends itself perfectly to being managed by Software Defined
Network servers. If you follow the networking space somewhat
closely, you know that SDN is the new rage, since it makes it much
simpler for carriers to adjust their networks to their customers'
needs in real time. But effective SDN management is easier said
than done, especially if the software must control several working
parts of different origin. On the other hand, it becomes relatively
simpler and more efficient if the software needs to speak a single
language easily understood and coherently applied by the entire
data transfer process.
The "Razor / Blade" Model
Infinera's business is pretty much a straightforward "Razor/Blade"
model. The company earns its footprint in carriers' networks by
selling them DTN-X boxes with a starter amount of Tributary Access
) and Transport Line Cards (TLC). The boxes carry margins only in
the mid-30%. The high profit stage of the business kicks in when,
over time and as network's demand rises, the carriers fill in the
boxes with high-margin (50-60%) TAMs and TLCs. The "fill in" cycle
can last several years until a whole new generation of technology
is ready for deployment. As a point of reference, INFN still draws
a significant portion of its revenues from sales of 10 GB TAMs into
the six-year-old DTN boxes.
It's fair to say that, if DTN-X box sales develop as suggested so
far by the company, this product line is likely to have much better
penetration and success than its 10 GB precursor.
Counterintuitive as it may seem for a high technology company, I
tend to approach INFN's stock as if it were a deep-cyclical. That
means I want to buy the stock when it is very expensive and I want
to sell it when its business reaches peak profitability and the
stock appears inexpensive using various earnings measures. At the
peak of the last cycle in Q2 of 2008, INFN traded at an EV/EBITDA
of 10, on quarterly revenues of approximately $160 million and
EBITDA of $45 million. If the business simply gets back to that
kind of revenue run rate and profitability by 2015, the stock could
reach the mid to high teens before then.
Also consider the following: 1) back in 2008 INFN relied on a
single customer for almost 50% of its business. This time around
the company has already sold boxes into 27 different customers, and
CenturyLink was the largest customer at just above 10% of revenues;
2) widening its revenue base, and/or adding another high-profile
tier 1 customer (
) tech folks have appeared with Infinera executives at several
recent conferences) would meaningfully de-risk INFN's business and
increase its valuation range; and 3) barring some other macro
disaster, this product cycle could last well past 2015.
The number of competitors in this space is limited primarily to
CIEN and ALU. Infinera's management has made it very clear that the
Chinese market is not open to foreign companies, in the same way
that US the market is not totally open to China's Huawei for the
same reason. But price competition between these few providers is
fierce, especially when it comes to establishing the initial
presence in the network.
Second, due to the limited number of buyers of this type of
technology, orders can be very lumpy. Having followed INFN for
several years my sense is that investors and traders understand
this and do not overreact to quarterly misses or beats. That said,
it makes it a lot harder to model numbers and valuation
The first time around INFN's potential was stunted by the financial
crisis, and its subsequent decision to bypass an entire product
cycle and bet the farm on the transition to the 100 GB technology.
By all indications the gamble appears to be paying off. INFN is
rolling out a best-in-class solution, and barring another macro
disaster the runway for INFN DTX-N boxes and blades should last
several years. If INFN merely returns to the 2008 revenue and
profit run rates, and its stock is given the same kind of valuation
it garnered back then, there is 50 to 70% upside within the next 24
months. More blue chip customer wins and/or a higher multiple could
reasonably push the stock back to its all-time high in the
mid-$20s. I have a significant long position, which I hedge
periodically with long-dated put options as insurance and for cash