Finisar: Are the Rumors True?

There were rumors going around on Wall Street that fiber-optics components supplier Finisar (NASDAQ: FNSR  ) could be bought out by its client, Cisco (NASDAQ: CSCO  ) . Barron's ran a story in February that Cisco could consider buying Finisar for around $27-$28 a share, given the rising importance of optical components in data communications.

Cisco will have to pay a higher price
But there hasn't been much development on this front so far in the last two months. On top of that, Finisar has recorded solid gains on the back of impressive results. The company's top and bottom lines rose 23.4% and 175% year over year, respectively, in the last reported third quarter. The outlook for the current quarter suggests that such remarkable growth rates will be seen even in the future.

Finisar has done very well in recent quarters because of increased optical spending in both data communications and telecom. A solid and diversified customer base, which includes Cisco, Ciena (NYSE: CIEN  ) , AT&T, Huawei, etc., has been important to Finisar's success so far. Moreover, Finisar's earnings are projected to grow quite rapidly in the coming years, with Yahoo! Finance projecting a 25% annual increase over the next five years.

As such, even if Cisco has designs of acquiring Finisar, it will now have to pay a higher premium since the stock is already touching $27 a share.

Product development moves
Finisar has launched a slew of new products in the past year, with more in the pipeline. Recently, the company launched new 100G transceivers, such as its CFP2 LR4 product, and it is now working on the next-generation CFP4 product. Finisar's vertically integrated business model helps it deliver efficient solutions to customers with low power consumption. As a result, Finisar's solutions have gained traction in 100G and 200G coherent metro and long-haul markets. 

On the telecom side, Finisar is now shipping beta samples of the tunable SFP+ modules. Again, these modules consume less power and should help Finisar tap the fast-growing market for data centers and telecom. 

In addition, Finisar has now completed the acquisition of u2t Photonics, whose high-speed receivers and photodetectors are used by several system manufacturers. The acquisition will strengthen Finisar's product offerings as it will be able to offer a comprehensive suite of optical components to customers, while strengthening its vertical integration further.

End-market growth
Datacenter deployment is on the rise. The roll-out of datacenters will lead to growth in 100G switches, and since Finisar is already specializing in this area, it stands to benefit largely. Global datacenter construction is expected to grow at a brisk pace of almost 22% till 2018, indicating the huge opportunity Finisar has ahead of it in data communications. 

Moreover, the shift from 10G products to 100G products should result in massive margin gains for Finisar. 100G optical products carry a higher gross margin to the extent of almost 15 percentage points, according to Goldman Sachs.

100G deployment in the U.S. has also gained steam as telecom providers are upgrading their networks. Verizon, for example, has rolled out 21,400 miles of 100G network and is pushing ahead with more deployments. Verizon has tapped Finisar customer Ciena to provide the gear for 100G. In fact, Ciena has close to 100 customers for its 100G gear, with 10 of them being Tier 1 customers.

In addition, Ciena also has a good number of international customers, with 40% of its revenue coming from outside of North America. Ciena expects to deploy networking gear in Latin America and India this year. These developments further suggest Finisar is in for good times ahead since it supplies components to Ciena.

The bottom line
Finisar might seem expensive at first, with a trailing P/E of 30. But, the stock is way cheaper than rival JDS Uniphase, which trades at 46 times earnings. Moreover, Finisar's terrific earnings growth so far and bright outlook justify its premium valuation. Also, considering the opportunities in the end markets and the company's product development moves, Finisar shares have a good chance of moving north in the future.

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