|Acacia Can Ride the Rise of Silicon Photonics, Says MKM|
Updated Sept. 18, 2017 7:25 p.m. ET
MKM Partners networking analyst Michael Genovese this afternoon initiated coverage of fiber-optic component supplier Acacia Communications ( ACIA) with a Buy rating, and a $64 price target, writing that it is the "only optical components name we would recommend to long-term investors with a 3+ yr time horizon."
Acacia is poised, he believes, to replace the “digital signal processor,” or DSP, that various networking vendors develop “in house” for their equipment.
"In our view, Ciena is the only in-house DSP maker that can challenge Acacia for technological leadership over the long term,” writes Genovese, referring to fiber-optic networking giant Ciena ( CIEN).
Acacia’s pace of innovation will outstrip most of these other vendors, he writes:
Optical transceivers operating at 40+G speeds and 50+km distances require electronic DSP chips to overcome dispersion. Several of the large Optical systems vendors have in-house DSPs they refresh every 2+ years, with each new DSP costing $50mn-$75mn to develop. Acacia is the leading merchant DSP vendor. It sells six DSPs, and it introduces a new one every 12-18 months. Merchant solutions have ~1/3 of the DSP market share. We expect this share to grow over time driven by purchases from vendors that have in-house DSPs. Some of the larger systems players are looking to diversify DSP sourcing for application flexibility and because of the high cost and long development cycles for in-house DSPs. In case you were wondering who those system vendors are, they include Ciena and all its competitors, as Genovese outlines in a chart in the report:
Some of the things that have recently hampered the company are looking like they’ll improve, such as the slump in demand from China that has hit all the vendors, writes Genovese:
Acacia missed 1H17 expectations because of weak Chinese demand, lumpiness in its DCI opportunity and a contract manufacturer product quality issue that caused supply constraints. All of these factors are now improving […] Acacia is seeing improved order rates, compared to 1H17, from its large Chinese customer (ZTE) driven by inventory normalization and formerly delayed backbone expansion projects that are now moving ahead. It is also seeing improved order rates in the DCI market, particularly from a Tier 1 Hyperscale that it sells 400G modules to directly.
He likes the company’s lead in moving up to higher and higher speeds with its DSPs:
The company has a new 1.2Tbps DSP chip scheduled to be generally available in mid-2018. It is also the strong market leader in the emerging CFP2-DCO module category with over 15 customers. ACIA has roughly 1,000bps higher GMs than its peers due to selling DSP-ASICs and from Silicon Photonics. We think it merits a valuation premium to the group
(For more on Ciena’s efforts with its WaveLogic DSP chipset, see my recent interview with Ciena CEO Gary Smith.)
Genovese sees the silicon approach of Acacia winning out over the exotic materials such as indium phosphide used in most of fiber-optics component manufacture:
We believe the demand trends in Optical transceivers, including faster and faster speeds and smaller and smaller form factors, bode well for SiPh over time. Acacia views CMOS-based optics as key to lowering overall system design costs. Photonic integration reduces the number of discrete components and saves on packaging costs. Acacia’s transceivers do not need lenses, do not need to be hermetically sealed, and have especially compact waveguide designs. Wafer-level testing (testing chips while still on the silicon wafer) also helps save on costs. Over the long term, we believe SiPh is the best positioned technology to deliver compact, low- power, low-cost modules. As the technology continues to develop, SiPh should enable greater component integration densities over time. It also offers co-packaging opportunities with electronics such as DSP-ASICs, amplifiers, and drivers. All of this promises to reduce the power consumption and costs of coherent modules going forward. Some of the near-term impediments that need to be overcome are the lack of uniformity in design, processes, and techniques being used by today’s SiPh industry players. However, as volumes increase we expect to see more uniform tools and processes take center stage.
As far as estimates, Genovese sees Acacia making $417 million in revenue and $1.90 per share in the fiscal year ending this December, just slightly above consensus for $416 million and $1.87.
For 2018, he models $513 million and $2.59 per share, which is also higher than consensus for $416 million and $1.87 per share.
For a different take on silicon photonics, see my recent interview with Stefan Murry, the CFO of optical component vendor Applied Optoelectronics ( AAOI).