2023-03-07 11:56:23 ET
Summary
- Applied Optoelectronics Inc.'s transceiver business has continued to underperform.
- The company plans to sell the data center business to Yuhan Optoelectronic Technology for $150M, with management confident the deal can close in 2023.
- Applied Optoelectronics Inc. has been recording robust growth and should shine even more when the company re-invests proceeds of the sale into the segment.
A few days ago, I was going through my stock screener for the semiconductor industry when I noticed that Applied Optoelectronics Inc. (AAOI) has emerged as one of the best-performing stocks in the sector so far in the current year. AOI stock has risen 47.9% in the year-to-date, easily outpacing industry benchmarks such as the iShares Semiconductor ETF ( SOXX ) and the VanEck Semiconductor ETF ( SMH ) which have gained 20.4% and 20.6%, respectively, over the timeframe.
AOI is a high volatile stock, with the shares jumping nearly 50% in a single day in September after the company announced that it had entered into a definitive agreement for the sale of its manufacturing facilities in China and certain assets related to its transceiver business to Yuhan Optoelectronic Technology for $150M. Unfortunately, the shares came under pressure again after another set of disappointing results in November, including a huge revenue miss. Thankfully, its latest earnings scorecard was much better with revenue and earnings both topping Wall Street's expectations, and AOI shares do not appear to be in imminent danger of crashing again.
Whereas the short-term outlook for AOI is positive, I believe that the major business model reboot the company is undertaking will also be good for the long-term performance of the stock just as it has been for another semi stock I follow: Lattice Semiconductor (LSCC).
Business Model Transition
Applied Optoelectronics is a leading provider of fiber-optic access network products for the internet datacenter, cable television ( CATV ) broadband, telecom, and fiber-to-the-home (FTTH) markets. Its largest business segments are CATV (62% of company revenue last quarter) while its data center products including transceivers contribute 27% of company revenue. According to AOI's management, the majority of proceeds from the sale will be invested in the company's other segments, particularly in the CATV business and some newer laser-related products.
Prior to the deal closing, AOI will also invest 4-10% of the estimated proceeds in exchange for a 10% stake in Yuhan Optoelectronic while the rest of the proceeds for general working capital purposes. AOI will continue using the manufacturing facilities in China on a contract basis to make certain CATV products.
... it is in the best interest of our shareholders for AAOI to exit the transceiver market and focus resources on our CATV business and manufacturing lasers and laser components for the datacenter, CATV, telecom, and FTTH markets, " said AAOI CEO Thompson Lin.
Obviously, the market perceives this arrangement as a good deal for the company, meaning AOI share performance hinges, to a large degree, on whether or not the sale will go through. The good news is that the company remains confident of completing the deal in the current year. In its latest earnings call, here's what AOI's Chief Financial Officer and Chief Strategy Officer Stefan Murry had to say regarding the sale:
… we continue to anticipate that the transaction will be completed in 2023 and is subject to customary closing conditions and regulatory approvals, including CFIUS and ODI. We continue to advance work on these required regulatory approvals. As part of this process, Yuhan has disclosed additional details regarding their financials, including new details regarding the composition of their ownership group. And based on this new information, we continue to be optimistic that regulatory approval of this transaction both in the U.S. and China is achievable .''
Sale of the transceiver business is a great move by the company because the latest set of results suggest that the data center segment is in terminal decline. Total revenue for the fourth quarter increased 13% year-over-year to $61.6 million, thanks to robust growth by the CATV segment which brought in revenue of $38.2 million, good for 53% year-over-year growth and 22%. As expected, AOI's data center segment continued to be a major laggard: revenue came in at $16.5 million, down 35% year-over-year and 7% sequentially, which management said was a result of customers continuing to manage inventory levels of older products during the major transition to 400G. The sharp revenue contraction by the segment was, thankfully, partially offset by an increase in 400G revenue, which the company said more than doubled sequentially. In the fourth quarter, 71% of the company's data center revenue came from 100G products, 11% was from 40G transceiver products, and 8% was from the 200G and 400G transceiver products. Revenue from our telecom products of $6.4 million was up 94% year-over-year and down 7% sequentially. AOI's margins are also improving courtesy of an improving product mix: non-GAAP gross margin clocked in at 21.4%, above the company's guidance range of 17.5% to 19.5% and was up from 18% in Q3 of 2022 and up from 17.6% in Q4 of 2021.
AOI shares first came under serious pressure in 2017 when 40G sales began dropping at a faster-than-expected clip. But with the CATV business doing great, cutting ties with a data center business that might not stabilize any time soon looks like a prudent decision. A big reason why AOI's CATV business is growing so fast is due to the ongoing DOCSIS 4.0 network upgrades. A good case in point is Charter Communications (CHTR) which, back in December, announced plans to spend ~$5.5 billion over the next several years on network upgrades.
The Takeaway
The one big concern regarding AOI's new business model is that it's very reliant on a few big customers to drive the topline. For the full year, the company had two customers contributing 10% or greater of company revenue, one in the CATV market and one in the data center market. Of these two customers, one contributed 47% and the other 18%. However, the company revealed that it's had some success in executing price increases with some customers, which helped improve margins.
Overall, I think AOI shares have plenty of upside if the sale goes through as planned. At a current share price of $2.78, AOI shares are a long way off the all-time high of nearly $100 they hit in 2017. However, successful business transitions can pay off big time as I explained with Lattice Semiconductor .
For further details see:
Model Transition Positions Applied Optoelectronics For Long-Term Growth