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Will Finisar Finally Hit a Higher Gear?

Finisar (NASDAQ: FNSR) has been finding it difficult to stage a comeback ever since it lost Apple's (NASDAQ: AAPL) lucrative 3D sensing business to rival Lumentum last year. The company reportedly failed to get its technology ready on time, forcing the iPhone maker to look elsewhere to satisfy its hunger for these chips, and the fallout continues.

Finisar management, however, is hoping for a turnaround as the year progresses. But will it be able to deliver this time, or will the company continue its trend of promising the moon to investors and then failing to deliver?

The top three-quarters of a man's face, surrounded by questions marks drawn on the wall behind him.
The top three-quarters of a man's face, surrounded by questions marks drawn on the wall behind him.

Image Source: Getty Images.

Apple could give Finisar a boost this year

Finisar failed to score the Apple win last year, but Cupertino was hard-pressed to stitch together a reliable supply chain for the 3D-sensing-equipped iPhone X. So Apple decided last December to write a $390 million check to Finisar to help the latter boost its production of 3D sensing chips, ensuring that it doesn't run into any production constraints like last time.

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Finisar investors now expect the company to find its way into Apple's next-generation smartphones, and management didn't disappoint on the latest earnings conference call. CEO Michael Hurlston said that he expects to see "an increase in demand for our VCSEL laser arrays for 3D sensing applications in the second fiscal quarter in connection with the expected timing of the new product introductions by our customers." Finisar watchers interpret that to mean the iPhone.

Finisar's fiscal second quarter runs from August through October, which coincides with the ramp-up of Apple's iPhone production. This should give Finisar's top line a solid boost as Apple is expected to manufacture around 80 million to 90 million new-generation iPhones in the second half of the year.

Assuming that half of these iPhones are equipped with 3D sensing capabilities -- and Finisar splits this business evenly with Lumentum -- that means Finisar's chips could find their way into 20 million iPhones. This could boost the company's revenue by $100 million in the second half of the year, as each 3D sensing chip reportedly costs $5.

By comparison, Finisar pulled in a combined $664 million in revenue in the fiscal second and third quarters last year, so that would be a 15% boost. This sounds great, but there's no guarantee of a comeback given the other factors at play.

But will it be enough?

A closer look suggests that Apple won't be a big driver for Finisar. The company pulled in $1.3 billion in revenue during the latest fiscal year. This means that sales to Cupertino would possibly be less than 10% of Finisar's total revenue, and probably be just enough to offset the weakness in the telecom side of its business.

Finisar gets 20% of its revenue by supplying telecom products, mainly to carriers in China, but this business has been under stress for quite some time. This side of Finisar's business fell a massive 32% year over year during the latest quarter, on the back of lower pricing and weak demand, with revenue dropping to $62 million.

Moreover, the continuous price erosion of telecom products in the Chinese market (thanks to a mix of weak demand and stiff competition) has been taking a toll on Finisar's margin profile.

Period

Q3 2017

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Telecom revenue (in millions)

$111

$91

$84

$76

$66

$62

Finisar gross margin

35.9%

36.2%

33.7%

29%

28.6%

24.7%

Data source: Finisar quarterly reports. These are fiscal years.

This business could run into further trouble as China's Ministry of Industry and Information Technology recently directed Chinese telecom companies to buy optical components from local vendors. This is bad news for U.S.-based Finisar given its exposure to the Chinese market. In fact, market research firm Cignal AI estimates that Western vendors like Finisar could witness a 30% drop in their addressable market if Chinese firms favor local suppliers.

No turnaround here

In all, Finisar's Apple-related gains won't move the needle much for the company given the other challenges it faces. The company expects its top line to drop around 8% in the current quarter, while adjusted earnings per share are expected to drop from $0.40 in the prior-year period to $0.13.

The only way Finisar can make a comeback is by finding a broader customer base for its 3D sensing chips beyond Apple. But it will run into stiff competition from Himax and Qualcomm. So Finisar is devoid of any real catalysts right now, and it looks as if it isn't going to get out of its slump anytime soon.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.