Applied Opto Surges 13%: All About the Cloud

A "QSFP+ 40-gig MPO MMF 850 nanometer 150-meter transceiver. Illustration: Applied Optoelectronics Inc.

Shares of fiber-optic component vendor Applied Optoelectronics (AAOI) are up $5.86, or almost 13%, at $52.67, after the company yesterday afternoon reported Q1 sales merely matching analyst’ expectations, but beat easily with its Q2 view — a relief in a week when Oclaro (OCLR) and Inphi (IPHI) both had glum news for the group, continuing to see pressure from slowing China sales.

Rather, the company is riding the ramp in spending in cloud computing data centers, and the Street sees no end in sight for it, given company comments suggesting they can barely build the stuff fast enough to meet demand.

Price targets and estimates are rising today at several shops:

Piper Jaffray’s Troy Jensen today reiterates an Overweight rating on the shares, and raises his price target to $65 from $58, writing that “the upbeat Q1 results were driven by robust demand for 100G transceivers, with the ramp in 100G optics and scale efficiencies driving impressive margin expansion."

His point is that the industry is struggling just to produce enough of 100-gigabit-per-second transceivers, and that should benefit Applied because it is “vertically integrated,” meaning it can make more of its own stuff itself.

This quarter was all about Amazon (AMZN) and Facebook (FB), he writes, less so Microsoft (MSFT):

Growth in the Data Center business was once again driven by their largest customer, Amazon (which we believe accounted for 56.0% of total sales) and FaceBook (19% of sales). Which combined for $72 million is sales and increased roughly 15% q/q. Microsoft has historically been a 10.0% customer, but due to non-AAOI related issue, we believe Microsoft slowed spending in the March quarter. From a product perspective, demand continued to be led by healthy sales for both 40G and 100G products, which accounted for 62.0% and 30.0% of total datacenter revenues, respectively. We remain encouraged with the ramp the company is seeing for 100G optics, and in Q1 100G revenues increased 76% sequentially to $23.9 million. Looking forward, we believe AAOI remains in prime position to see healthy demand continue for 100G and stability in 40G for the next few quarters. We believe the industry will be capacity constrained for 100G Datacom optics throughout 2017, and given AAOI’s vertically integrated model, we believe they are one of the best positioned Datacom optic transceiver supplier.

Jensen raised his estimates for this year to $430 million in revenue and $4.52 per share in net income from a prior forecast of $378 million and $3.36 per share. For 2018, he’s now at $494.5 million and $4.59 per share, up from $453.7 million and $3.68 per share.

Cowen & Co.’s Paul Silverstein reiterates an Outperform rating, and raises his price target to $94 from $75, writing that the stock is “significantly under-appreciated and under-valued."

"Perhaps best speaking to the strength of AAOI’s business,” observes Silverstein, is the company’s comment that "Right now we're basically shipping everything we can manufacture, so the growth rate is not dependent on demand. It's dependent on our ability to continue to ramp our manufacturing."

He liked the “risk and reward” equation before, he writes, but now “we like the risk-reward that much more with the oper outlook having improved significantly driven by strong ramp in Data Center revenue from AAOI’s Cloud Titan customers."

The company’s reliance on the cloud customers, which had been seen as a risk, now “has become a solid virtue,” he writes.

And Silverstein thinks the results also undermine bear arguments about increased competition:

AAOI’s projection of over 85% (which translates to over $170M) Y/Y Data Center revenue growth to over $370M in Data Center revenue in CY17 appears to undercut —at least for CY17--what appears to be widespread investor concerns that AAOI eventually will suffer significant market share losses and price/GM erosion from eventual new entrants in AAOI’s 100G data center business (i.e., at one or more of AMZN, MSFT and FB).

Silverstein raises his estimates for this year to $459 million in revenue and $5.21 per share in net income, from a prior $402 million and $4.16.

For next year, he’s at $546 million and $5.30 per share, up from $462 million and $4.50.

And Raymond James’s Simon Leopold reiterates a Strong Buy on the shares, and raises his price target to $100 from $74, writing that “shares have been pressured by exaggerated fears of competition,” but, “we believe the data center market demand greatly exceeds supply, so we think there is opportunity for multiple players."

Is the competition real or imagined, he asks:

Applied Optoelectronics shares have been dogged by speculation of share loss and increased competition that management refutes. While we believe competition is increasing, the fears appear exaggerated. MACOM and private companies have created much of the noise. AOI gains advantages via vertical integration, an increased level of automation, and a breadth of products. AOI believes it can maintain its leading share in web scale accounts at 100G. We envision increasing competition, in part as telco focused suppliers seek QSFP28 opportunities considering the pause in China. Strong gross margin demonstrates limited competitive threats. We also think the data center market is healthy enough to support multiple players, and account for the risk in 2018 by modeling decelerated growth and margin compression.

By his reckoning, Facebook makes a second appearance as a major customer this quarter, alongside Amazon:

Applied Optoelectronics disclosed two 10% customers this quarter contributing to 56% and 19% of total sales, and we believe these were Amazon and Facebook, respectively. This is the second time that Facebook shows up on the +10% list, according to our estimates, and we welcome the diversifying element of a new material customer for AAOI in the quarter. Microsoft contributed 18% to AAOI’s revenue in 2016 but fell below 10% this quarter; we expect it returns as a 10%+ customer later this year. We do not anticipate share loss at the account, and associate the investment pause to architectural shift/planning that impacted multiple networking vendors in December.

Leopold raises his estimates for this year to $445 million in revenue and $4.63 per share in net income, from a prior estimate for $419 million and $3.63. For next year, he now sees $543 million and $5.74 per share, up from $483 million and $4.19 per share.