Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Infinera's (INFN -0.27%) purchase of Coriant for $430 million last year transformed it into "one of the largest vertically integrated optical network equipment providers in the world," as the company boasted at the time. But as we've learned this morning, that may not necessarily be a good thing, because it makes Infinera even more dependent upon the world's buyers of optical network equipment -- cable companies in particular.
What happened to Infinera today
Bright and early Monday morning, investment bank JPMorgan cut its rating on Infinera stock from neutral to underweight (i.e., sell). Part of the reason for this, says StreetInsider.com, is because the analyst sees "long-term risks relative to the acquisition." But the bigger reason is the "heightened level of near-term and medium-term risks from the much more moderate level of capex spending from cable customers."
Let's address those one at a time.
Balance sheet risk
That $430 million price tag may not sound like a lot of money on Wall Street, but for Infinera, whose stock is down 65% over the past year, it kind of is. With a market cap of just $537 million, Infinera's debt load of $358 million is about two-thirds the size of the value of the company.
That's problematic when you consider that it hasn't generated any positive free cash flow in at least three years, according to data from S&P Global Market Intelligence. Infinera's cash situation is also getting worse, as cash from operations gets more and more negative. Without cash to pay it down, the company's debt load is only going to balloon, and shelling out another $230 million for Coriant (the remaining $200 million was paid in stock) isn't going to help matters.
Buying Coriant was supposed to help fix that. At the time the acquisition was announced, Infinera believed buying Coriant would help to double its revenue and begin adding to earnings in 2019. So far at least, that isn't how things are working out. In the year's first quarter, Infinera posted more than $121 million in losses -- nearly five times what it lost in Q1 2018 -- and ended its report with a prediction of worse-than-expected revenue and a Q2 loss.
The revenue outlook is especially troubling, as it appears to back up JPMorgan's warning about moderating capital spending trends among cable customers. In that regard, it's worth remembering that earlier this year, independent sell-side research firm MoffettNathanson said that total capital spending by telecom and cable companies this year is expected to be "relatively restrained," rising only 3.3% over 2018 levels, and down from 4.6% growth last year. 2020 will be worse, with capex falling 2.4%, and 2021 capex declining 2%. This hardly seems to back up the FCC's 2017 argument that repealing net neutrality would "accelerate" broadband investment.
Individual company numbers tell the tale. Last year, for example, ArsTechnica pegged Comcast's cable division's capital investment at just $7.7 billion, down 3% from the nearly $8 billion Comcast spent on cable infrastructure in 2017. Both Verizon and Charter Communications, furthermore, said they would be reducing capital investment in 2019. Charter, which spent $11.8 billion on capex last year, will cut nearly $2 billion from its budget this year: "We currently expect capital expenditures, excluding capital expenditures related to mobile, to be approximately $7 billion in 2019, versus $8.9 billion in 2018," the company said in its earnings release.
What it means to investors
Commenting on the trend, JPMorgan opines that "moderating cable capex will likely drive Infinera to return to profitability and cash flow generation later than currently guided to by the company, and increase the medium-term risks relative to materially underperforming stated (gross) margin targets, led by a much lower scale of revenues than anticipated at the time of the [Coriant] acquisition."
In that regard, it's worth noting that analysts who follow Infinera already don't expect to see the company turn GAAP-profitable before 2022 at the earliest. Pro forma profitability might arrive a year earlier -- or if JPMorgan's worries over weak cable company spending prove correct, it might take even longer than that.
With no GAAP profits or free cash flow to hang a valuation on, balance sheet worries increasing, and now the prospect of slower growth, it could be a long time before Infinera shareholders begin to see a positive return on their investment.