Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get bull's-eyes on their backs and are targeted by other companies looking to disrupt their products by selling cheaper alternatives that still prove "good enough." Even if a company continues to dominate its particular field, other changes in technology can shift spending away from its products. Think about how Microsoft still dominates PCs, but it's pressured by sales shifting to mobile devices like smartphones and tablets.

With that in mind, today we're looking at how Infinera (Nasdaq: INFN) innovates. Technology companies can innovate either through acquisitions or spending more on research and development. We'll compare Infinera's spending in these areas to that of its closest peers and assess whether the company is investing enough in its future.

Research and development
Over the past five years, Infinera has spent an average of 31% of revenues on R&D. The table below summarizes how Infinera's R&D expenditure relative to revenues compares to some of the company's closest peers:

Company

2006

2007

2008

2009

2010

LTM

Infinera

59.2%

24.8%

15.5%

31.5%

26.1%

26.9%

Ciena (Nasdaq: CIEN)

19.7%

https://w1.ciqimg.com/CIQDOTNET/images/financial_singleBlackLine.gif?urwvid=1879213470 16.3% https://w1.ciqimg.com/CIQDOTNET/images/financial_singleBlackLine.gif?urwvid=1879213470 19.4%

29.2%

https://w1.ciqimg.com/CIQDOTNET/images/financial_singleBlackLine.gif?urwvid=1879213470 26.5% https://w1.ciqimg.com/CIQDOTNET/images/financial_singleBlackLine.gif?urwvid=187921347024.2%
Alcatel-Lucent (NYSE: ALU)

12%

16.6%

16.2%

16.6%

16.6%

16.4%

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years, while yearly total is for company fiscal years closing in that period.

It shouldn't come as any surprise that Infinera must spend such a high proportion of revenue on R&D. After all, not only does the telecom industry in general have high levels of research spending, but Infinera's whole raison d'etre is superior technology.

Infinera's "photonic integration technology" removes components from optical equipment and gives telecom operators a way to scale their network in a more cost-effective manner. That's a compelling sales pitch, but there are some challenges ahead.

Namely, Infinera has hit some road blocks releasing its next generation 100G product. While 100G products are still a small market, they're also the future of optical transport equipment. If Infinera sees any more delays getting its 100G solution to market, its past R&D successes could be overshadowed by its 100G failures.

Acquisitions
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses like hard drives and PCs while it focused on acquiring additional services and software expertise that have transformed its business model.

However, on the opposite end of the spectrum, Hewlett-Packard is often criticized for under-investing in research and development to the point that it has to overpay on acquisitions to catch up with competitors.

Investors should remember, most of all, that companies are valued by the cash flow they can bring in for their shareholders over time. If companies need to continue making purchases in perpetuity to keep growing, that amounts to a reduction in cash flows, and investors should treat acquisition spending as a continuing outflow against cash flow. With that in mind, let's take a look at Infinera's free cash flow over the last five years against cash spent on acquisitions.

Infn

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years, while yearly total is for company fiscal years closing in that period.

Unlike most of its peers in technology, Infinera isn't a serial acquirer. The company's focus is still around getting broader acceptance of its products and pushing forward to next-generation equipment using its own photonic integration technology. Infinera's cash flows need no adjustment for acquisitions, and they'll likely remain that way for some time.

Final thoughts
Infinera is a fascinating company. Its products are undoubtedly very competitive, but breaking into the telecom equipment industry, which is populated by large rivals hawking wider product portfolios, is difficult. In the end, I thought enough of Infinera's end-market opportunity and unique technology that I bought some shares in the portfolio I manage on Fool.com.

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Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of International Business Machines, Microsoft, and Infinera. Motley Fool newsletter services have recommended buying shares of Infinera and Microsoft. Motley Fool newsletter services have recommended creating a diagonal call position in Microsoft. 

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