Acacia Communications (NASDAQ:ACIA) serves the long haul, metro, and data center interconnect (DCI) markets by boosting the capacity of existing networks. Acacia competes with companies like Infinera (NASDAQ:INFN) in this space, but its 400G chipset -- which is smaller, denser, and more power-efficient than many rival products -- gives it a competitive edge. Acacia is also more exposed to the higher-growth metro and DCI markets than long haul-oriented companies like Infinera.
Acacia was one of the hottest IPOs of 2016, skyrocketing from its IPO price of $23 to $119 in just four months. However, the stock has declined almost 70% since then, with the mixed fourth-quarter numbers it reported on Feb. 22 causing an 11% drop the following day.
So is Acacia a contrarian buy or a falling knife? Let's take a closer look at a few reasons to either sell or buy this out-of-favor stock.
Six reasons to sell Acacia
Acacia's revenue fell 39% annually to $86.6 million during the quarter, missing estimates by nearly $2 million and representing its third straight quarter of negative growth.
Like many of its peers, Acacia is struggling with sluggish demand in China, cyclically weak demand from traditional telcos, and volatile demand for DCI solutions. Its customer base is also extremely concentrated, with almost 80% of its revenues coming from its top five customers.
Acacia expects its first-quarter revenue to fall 35%-42% annually. Analysts expected a much milder drop of 19%. For the rest of 2018, CFO John Gavin remains "cautiously optimistic" about Acacia's prospects.
Acacia's non-GAAP operating expenses accounted for 34% of its revenue during the fourth quarter, compared to just 16% in the prior-year quarter. It attributes those higher expenses to foundry and development milestone payments along with strategic R&D investments, but those higher expenses could throttle its earnings growth as its revenues decline.
Acacia's non-GAAP earnings fell 71% annually to $0.27 per share during the quarter, which still beat expectations by two cents.
But for the first quarter, it expects earnings of just $0.01 to $0.10 per share, which marks a steep drop from its earnings of $0.77 a year earlier and misses analysts' projections of $0.28 per share. Acacia also remains unprofitable on a GAAP basis.
Analysts expect Acacia's revenue and earnings to decline 3% and 40%, respectively, in 2018. However, the stock still trades at 35 times its projected EPS for 2018 -- which is a lofty multiple for a company with negative growth.
Lastly, Acacia's insiders don't have much faith in the company's near-term future. Over the past 12 months, insiders sold 2.88 million shares on the open market, but purchased just over 332,000 shares.
Two reasons to buy Acacia
Acacia's growth figures look terrible, but it's a cyclical play which could recover quickly if demand in China accelerates.
During the conference call, CEO Murugesan Shanmugaraj stated that while China "remains challenging" and "the timing of deployment growth remains uncertain," some top OEMs and carriers in China had stated "that the long-term fundamentals remain intact," fueled by rising demand for higher bandwidth connections in provincial and metro networks.
Shanmugaraj also noted that "recent comments" from an unnamed industry peer indicated that Chinese orders of fiber components rose at the end of 2017 -- which "historically has signaled the early stages of network expansion."
Acacia's gross margin also remains high, despite the aforementioned concerns about its operating expenses. Its non-GAAP gross margin of 44.5% represents a decline from 48.3% in the prior-year quarter, but remains comfortably higher than Infinera's non-GAAP gross margin of 37.5% in its latest quarter.
The bottom line
I love a good turnaround play, but Acacia looks more like a falling knife. Its year-over-year revenue and earnings declines aren't slowing down, and its P/E ratio is still too high. Investors should steer clear of this stock until the Chinese market stabilizes.