(OCLR) Oclaro! What Now!

OCLARO (OCLR)

Oclaro’s Stock price fell from the upper teens in March 2011, less than one year ago, to the low single digits.  Let’s look at what Oclaro does, and try to find out what happened in 2011, to give us some insight and see if the company is in trouble or can it be turned around?

What do they do and why did Oclaro outperform in 2010?

The value of Oclaro rose during 2010 due to improved demand for their products. The products they design are used to improve reliability and cost efficiencies of fiber optic networks, probably a good demand environment going forward considering the pace at which mobile broadband and cloud computing are being used . The demand environment is expected to be robust and likely to accelerate for the near future, as network owners try and satisfy this demand.  Note here, the 42% increase in revenue from the third quarter of 2009 to the third quarter of 2010. 

Q3 2009	Q4 2009	Q1 2010	Q2 2010	Q3 2010	Q4 2010
$85	$93M	$101m	$101m	$121m	$120m

 Oclaro has a unique business model in that they have very low variable costs.  The reason, I suspect, is the employees, mostly engineers, earn salaries.  In addition, material costs variability seem to be stable.  Once Oclaro is able to overcome its fixed costs with revenue, profit margins and EPS can show very significant sequential growth percentage increases. Be cautious because, when revenues do not overcome costs, profit margins can show very significant percentage declines, and thus earnings can be significantly negative when revenues are only slightly below its breakeven levels. The result of this type of model is one of the most volatile stocks that can be found.    

What Happened to Oclaro in 2011?

2011 was an especially challenging year for all companies operating in the optical space, especially Oclaro. Investors were beginning to anticipate Oclaro, finally, being able to produce sustainable revenues above breakeven levels and the price rose to a high of around $19 on Feb. 25, 2011.

There were 4 events, outside of the company’s control, that caused some difficult headwinds in the entire optical space in general.  I included the dates of the events so you can see the affects these had on the stock price.

1.        Japanese Tsunami:  March 11, 2011

2.        AT&T Attempt to purchase T-Mobile USA: March 20, 2011

3.        European Financial Crisis-Spring, Summer, and Fall 2011

4.        Thailand Floods- October 11, 2011

The Japanese Tsunami put a strain on some parts supply chains and network spending, in Japan, slowed as the country focused efforts on recovery efforts. The tsunami was a headwind, is now a tail wind, as Japan focuses its efforts on reducing the power it takes to run its networks.  AT&T focus for 2011 was to purchase the assets of T-Mobile caused network spending to focus in other areas than optical. This will may be turning in to a tail wind as seen in some recent headlines.   The European financial crisis caused investors to flee “risky” stocks in 2011, as well as some business softness in some economic indicators coming out recently. Finally, there was the Thailand Floods.  A Fabrinet facility in Thailand flooded and another nearly flooded and remained closed for weeks. This caused the very significant revenue decline from q3 to q4 and some soft guidance in Q1.  I believe we will find this to be a conservative outlook by Oclaro.

Q1 2011	Q2 2011	Q3 2011	Q4 2011	Q1 2012 Guidance
115m	109m	105m	86m	$90-$97m

 What does Oclaro’s business look like now? 

What we know now, from the most recent 10Q is that Oclaro will be close to, if not full, manufacturing capacity in the June 2012 quarter.  We also learned that the top 3 clients in the fourth quarter were: Fujitsu, Ciena, and Infinera.  Looking into these companies is beneficial in understanding how Oclaro is doing with market share. 

The headlines suggest Oclaro is not merely hanging onto market share, but likely expanding it. Also, As businesses begin spending to improve their networks.  The stock price cleared “the Thailand Flood” price decline of $4.30 on decent volume but the market appears to be confused about network spending.  But as you can see below, the headlines suggest that is and will be doing very well.  Oclaro appears to be well in position to benefit and likely to earn sustainable revenue to cover fixed costs and ultimately sustainable profitability and make this a fantastic opportunity at $4.80.

Recent Headlines that suggest Oclaro’s top 3 suppliers exhibit strong business demand:

Fujitsu

1/30/2012 Fujitsu -Recently selected by AT&T to supply component parts within the optical transport network.

Infinera

1/11/2012 Infinera- Infonetics Research named Infinera as the number-one supplier of digital optical network solutions.

Ciena

2/6/2012 Ciena- Ireland selected Ciena to upgrade Ireland’s network infrastructure.

2/14/2012 Ciena- MKM Partners upgraded Ciena.  Here is what they said: “Our work suggests that 40G/100G transport and/or optical transport network (OTN) switching solutions from Ciena are gaining traction at historically large Tier 1 accounts like AT&T (T), Sprint Nextel (S), Comcast (CMCSA), BT Group (BT) and Telmex, and are also gaining share at accounts where Ciena has typically been smaller, such as Verizon Wireless [a joint venture of Verizon Communications (VZ) and Vodafone Group (VOD)]. Further, we believe that first-quarter 2012 capex budgets were recently released at AT&T and Verizon and order rates at these accounts should accelerate in the current quarter.

2/15/12-AT&T  Notter@ Jeffries says anecdotal evidence is that AT&T in the fourth quarter had cut business with vendors by as much as 50%-90%. But Notter reports that he is hearing that once the company’s budget is finalized, business trends will go back to Q3 run rate levels or better. “In total, the AT&T capex picture will look significantly better going forward,” he writes. Notter thinks the expected pick-up in spending from Ma Bell is not in Q1 guidance from the telco equipment vendors. “Our sense is that current investor expectations are quite low with respect to the possibility of a significant ramp in North American cap ex,” he writes. Notter points out that that Q4 results and Q1 guidance were “very disappointing” from companies like Ericsson, Juniper and Tellabs which have major exposure to both AT&T and Verizon. “We recognize that the Q1 guidance from many of these vendors doesn’t jive with our views,” he writes. “We think it’s a natural by-product of their despite to be conservative – particularly in the wake of recent disappointments. In total, we think there’s currently a significant gap between perception and reality on capex spending.” Notter adds that Juniper remains his favorite play in the group. He notes that other companies with significant AT&T exposure include Adtran, Alcatel-Lucent and Ciena.

Oclaro Longer Term?

On the most recent quarterly conference call, Alain Couder, CEO of Oclaro, said the company is reducing its quarterly fixed operating cost down to $110m over the next 2 quarters by performing a sale leaseback with a contract manufacturer in Shenzhen China. Oclaro says the will reduce headcount but keep R&D and other services permanently on site to monitor quality programs.  The cost reduction program, along with capacity repairs, and new products, Oclaro should be very close to sustainable profits after calendar Q2.

Jwells