Finisar Issues a Reality Check

OK, this is more than a mere correction. It's a downright reality check.

Finisar (Nasdaq: FNSR  ) just reported earnings, and the stock is on fire. I don't mean "on fire" as in rocketing to new heights but more like, "Sweet mother of sales, did anyone call 911 yet?"

The news
So Finisar's third quarter was just fine, more than meeting analyst expectations with 58% revenue growth year-over-year to $263 million and $0.47 of non-GAAP earnings per share. But management's outlook on the coming quarter fell far short of the average Street view. That's a mortal sin on Wall Street, particularly when you're looking at a high-flying stock that had gained 67% over the last three months and tripled in a year.

The third quarter set new records for sales and profits, driven by high demand for Finisar's high-end products including 40 gbps optical products. You'd be forgiven for seeing only blue skies ahead with that kind of data coming in.

But then the fourth quarter sounds like a heck of a downer. The factors adding up to a disappointing forecast include:

  • Inventory adjustment at some telecom customers.
  • Three full months of telecom sales at renegotiated -- read: lower -- prices.
  • 10 days of Chinese New Year celebrations shutting down business with customers in the Middle Kingdom.
  • And by the way, Chinese business isn't doing so well in general.

Finisar chairman Jerry Rawls told analysts that this should be a short-term slowdown rather than the end of a growth cycle, but that all signs point to an industrywide correction in China. "We're not the only ones in the industry that are saying this, though," Rawls said. "I will tell you that it is an industrywide phenomenon right now, and it's not limited to just one customer in China as well, so I don't know."

The impact
And that's exactly how the markets are taking this report. Finisar's shares are down 37% in late trading but the fallout descended heavily on Finisar's rivals, customers, and suppliers as well:

  • JDS Uniphase (Nasdaq: JDSU  ) , down 14%.
  • Oclaro (Nasdaq: OCLR  ) , down 17%.
  • Oplink Communications (Nasdaq: OPLK  ) , down 12%.
  • Finally, Ciena (Nasdaq: CIEN  ) took another 4.8% hit on top of the drastic fall after Monday's earnings report. Things can always get worse.

Now, keep in mind that we're supposedly looking at short-term concerns across the board. Long-term investors could get very happy (and rich!) buying in on shortsighted drops like this. Just remember that it might be a bumpy ride until all systems are go again, so it's no place for day trading or options close to expiration.

The opportunity?
Curiously, general network equipment vendors didn't take much of a hit despite Finisar's bleak outlook on Chinese telecom sales in particular. You'd think that Alcatel-Lucent (NYSE: ALU  ) and LM Ericsson Telephone (Nasdaq: ERIC  ) would be sensitive to that action. Maybe that connection isn't obvious to Alcatel and Ericsson investors, or those stocks would have plunged today as well.

Ciena's pain shows that a recent earnings report doesn't do much to inoculate these stocks from the Finisar Effect. Either Finisar's management is being unreasonably pessimistic about the coming quarter or the other guys didn't put enough salt on their own forecasts.

Back to reality
In any case, I suppose the optical networking market was overdue for a breather. This certainly qualifies, as Finisar hasn't traded at these prices since mid-December. If that doesn't sound overly harsh to you, you're absolutely right: Investors are still placing a high value on this industry because high-speed networks will continue to be in high demand for years to come. But near-term guesstimates simply got overheated and overly optimistic.

"Back to life, back to reality," as Soul II Soul sang back in 1989. Finisar is living that tune today -- and dragging an entire industry along with it.

Want to keep a closer eye on optical networking?

  • Add Finisar to your Foolish watchlist.
  • Add Oclaro to your Foolish watchlist.
  • Add Ciena to your Foolish watchlist.
  • Add JDS Uniphase to your Foolish watchlist.

You'll also gain access to a free report showing six more watchlist stocks that would give you wider and deeper insight into entire industries. Check it out -- it's free!

Fool contributor Anders Bylund holds no position in any of the companies discussed here. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Alpha owns shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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