The growing popularity of 3D sensing and augmented reality (AR) applications has turned out to be a boon for Lumentum Holdings (LITE 5.09%). The company has managed to capitalize on these fast-growing trends thanks to its supplier relationship with Apple (AAPL 2.45%), which came at the right time to help Lumentum overcome the slowdown in its traditional optical components business.
Lumentum management predicts that the company's 3D sensing revenue will double in the second half of the year as compared to 2017. But this could be just the beginning for Lumentum as the application of the chipmaker's technology beyond Apple's ecosystem could result in big long-term gains.
3D sensing applications will grow beyond the iPhone
Lumentum shot into the spotlight last year after it emerged as the sole supplier of laser dot projector hardware (technically called vertical-cavity surface-emitting laser, or VCSEL) for Apple. This chip is used to enable the iPhone X's TrueDepth front-facing camera, allowing the device to sense the depth and other characteristics of a user's face and unlock the iPhone using the Face ID feature.
It also powers other augmented reality features for Apple, such as Animojis, which need a 3D rendition of the user's face. The good news for Lumentum is that this technology won't remain limited to the iPhone as Android smartphone makers are also looking to jump on the 3D sensing bandwagon. In fact, TrendForce estimates that 3D sensing module sales will increase to $14 billion in 2020 from $1.5 billion in 2017 thanks to the adoption of the technology in Android smartphones.
Lumentum has already made a play to tap this huge market. The optical components specialist is supplying the diode laser to fellow chipmaker Himax Technologies (HIMX 0.11%), which is using the component in its SLiM (Structured Light Module) 3D sensing solution that's aimed at the Android market.
Himax has developed SLiM in partnership with Qualcomm. This bodes well for Lumentum given Qualcomm's clout in the mobile chip market. More importantly, Himax and Qualcomm have announced that SLiM is ready to go into mass production, and they are working with multiple smartphone makers to deploy this technology in their flagship devices in the first half of 2018.
Additionally, Himax is going after mid-tier and budget Android devices. The company expects to start shipments of this budget solution by the end of the year.
Global smartphone shipments are expected to increase to 1.7 billion units in 2021. The Android ecosystem currently accounts for 85% of the smartphone market, so it presents a far bigger opportunity for Lumentum as compared to Apple. Now, each VCSEL array reportedly costs $5. So even if half the smartphones sold globally deploy this feature in the coming years, Lumentum's top line could receive a massive boost given that it has generated just over $1.1 billion in revenue over the past year.
What about Apple?
Apple is the more immediate catalyst for Lumentum as it is currently the biggest buyer of VCSEL arrays on the market. It is estimated that Apple now supplies 40% of the chipmaker's top line as compared to none at the beginning of 2017. This is because Lumentum became Apple's sole supplier thanks to a reported inability of rival Finisar (FNSR) to meet Cupertino's specifications last year. But the iPhone maker didn't want to put all its eggs in one basket.
Apple gave Finisar almost $400 million to jump-start its VCSEL production back in December. Finisar is going to use this money to restart a 700,000-square-foot facility in Sherman, Texas. Not surprisingly, Lumentum shares fell immediately after the deal was announced.
But Lumentum management's recent comments indicate that it is still in a strong position at Apple. The company said during the last earnings call that it could start ramping up the production of VCSEL arrays in June to satisfy demand expected during the second half.
This doesn't seem surprising as Apple is expected to deploy Face ID across more of its products. The iPad Pro, for instance, could be released with this feature in June this year, which is probably why Lumentum is anticipating a sharp spike in demand. Apple sold 13 million iPads last quarter, which translates into an annual run rate of 50 million units.
There seems to be opportunity enough for both Lumentum and Finisar. But what separates Lumentum from Finisar is the former's tie-up with Himax, which, in turn, has tapped Qualcomm to boost its 3D sensing business. This should result in a massive expansion in Lumentum's revenue opportunity, paving the way for strong revenue and earnings growth in the long run.