Summary
- Rate hold until after the deal to sell its manufacturing facilities and other assets is closed.
- The question to ask is this: "What is the future of AAOI if the deal falls through?"
- As the company stands today, its CATV unit and 400G product shipments are at tailwind for the company.
- 40G sales are declining faster than anticipated.
Applied Optoelectronics, Inc. ( AAOI ) last earnings report was a fairly weak one, with 40G sales dropping faster the company anticipated.
While the company shared some of the strengths it had in the quarter, including CATV, 400G and telecom in general, the report was dominated by the proposed sale of its manufacturing and other assets associated with its transceiver business to China-based Yuhan Optoelectronic Technology for $150 million, and what type of company it will become post-closing, assuming it gets the go ahead to do so.
In this article we'll look at some of the recent numbers from its earnings call, and what it'll mean for the company if the deal goes through, and what its prospects are if it doesn't.
Some of the numbers
Revenue in the third quarter was $57 million, up from the $53.3 million in revenue generated in the third quarter of 2021. Revenue for the first nine months of 2022 was $161 million, up from the $157 million in revenue from the first nine months of 2021.
Revenue from its CATV unit was a record $31.3 million, up 35 percent from the third quarter of 2021, and up 32 percent from the prior quarter, meaning almost all of it came in the second quarter after a slow first half. CATV accounts for over 55 percent of the company's revenue.
Company 10-Q
Revenue from data center products was $17.7 million, down 26 percent year-over-year, and a huge 80 percent from the prior quarter. That comes from the faster-than-expected drop in 40G sales, as consumers transition to 400G. Data center accounts for 31.2 percent of revenue and will continue to drop from there in the quarters ahead.
Revenue from Telecom was $6.8 million, up from the $5.1 million in the third quarter of 2021. Telecom accounts for 12 percent of overall revenue.
Gross profit in the reporting period was $9.7 million, an increase from the $8.1 million in gross profit produced in the third quarter of 2021.
Net loss in the third quarter was $(15.6) million, or $(0.56) per share, compared with the net loss of $(15.8) million, or $(.058) per share in the third quarter of 2021. For the first nine months, the company had a net loss of $(40.6) million, compared to the $(43.1) million losses in the first nine months of 2021.
Gross margin in the reporting period was 18 percent, coming in at the high end of its guidance range of 16.5 percent to 18.5 percent.
Cash and cash equivalents at the end of the third quarter was $26.2 million, down from the $34.7 million at the end of calendar 2021.
Sale of assets to Yuhan Optoelectronic Technology
AAOI announced on September 15, 2022, that it had agreed to sale its "manufacturing facilities located in the People's Republic of China, and certain assets related to our transceiver business and multichannel optical subassembly products for the datacenter telecom and FTTH markets for a purchase price of $150 million."
While the closing will be subject to usual conditions, when dealing with China in the current geopolitical climate, it isn't over until it's over. In other words, until the deal is officially closed, I wouldn't count on it when making a decision on whether or not to take a position in AAOI.
How to view the transition in general is, if the deal does go through it'll without a doubt give a nice boost to its share price, which should raise the floor on the stock price even after it inevitably comes back down from the initial spike.
Management said the deal should be completed sometime in 2023.
How the company views the effects of the completion of the deal is, it would result in the company focusing on "growing its higher margin component chip business."
With the transceiver business of the company included in the proposed sale, it means there would be a strong possibility it could gain new customers from its current competitors in the transceiver market, in regard to its optical component products. That's important because optical component products usually have much higher gross margins. Another probable benefit from selling the company is concerning the hesitancy in Chinese companies buying components like transceivers from companies based in the U.S. By selling to a Chinese company, the result is likely to be winning more Chinese customers. How that helps AAOI is it should result in an increase in optical component chips that would be used in producing transceivers for the new Chinese customers.
The major benefit of the sale will be the cash it will make available to AAOI, which it can use to improve its balance sheet and boost R&D investment.
Beyond those two uses of the proceeds from the sale, the company will also focus on allocating some of the cash to its core businesses, including CATV, manufacturing of optical components, and its datacenter laser business.
Management believes that after it exits the transceiver and other businesses, it'll result in its remaining businesses being able to generate free cash flow while producing breakeven EBITDA after the deal is done. After the transaction is closed, the company believes gross margin will, within a year, increase to the upper 20 percent range. What happens if the deal falls through? I see the company being under pressure from the rapid decline in 40G, which as the company stands today, will be difficult to offset in the near term.
I think it will still be able to continue to grow incrementally across its various segments, but it'll struggle to make a profit under the current market conditions.
Without this deal I don't see the company doing much except fighting to maintain its current level of performance. If the deal were to collapse, so would AAOI's share price.
Conclusion
The share price of AAOI appears to have hit a bottom at around the $1.50 per share mark, and since its 52-week low of $1.48 per share in early July 2022, it has rebounded some after news of the proposed sale. Since than it has fallen back to trade in a range of approximately $2.05 per share to $2.40 per share.
I think it's probably going to continue to trade flat until confirmation the sale is going to go forward or not. Another catalyst would be the upcoming earnings reports, which I think are going to be weak, based upon the aforementioned rapid decline in 40G. Under that scenario, the share price will drop until the sale is approved or not.
With that in mind, I think it'll continue to have support at about the $2.00 mark until there is clarity concerning the deal, even if it temporarily corrects on a weak earnings report.
One last thing to consider is, the stock is thinly traded, so investors should be cautious concerning how big of a position to take because it could be hard to get in or out unless more volume than usual trades the stock. And if that volume does come in, it means it's share price is going to move up or down quickly, making it difficult to get in or out where you want.
For further details see:
Applied Optoelectronics: Relying Heavily On Asset Sale For Future Growth