It can be dangerous to have a good feeling about a company's stock, but not be able to back it up with strong quantitative data. And yet, that broadly describes most turnaround situations, as the timing and magnitude of earnings and cash flow recoveries are so hard to model accurately. With that in mind, I think Finisar (Nasdaq:FNSR) could be in for better days as upgrade cycles in the data center and telecom markets take revenue and earnings higher.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

The Company in Brief
Finisar is the largest player in the optical components space, holding about a 16% share of the market for products like transmitters, transceivers and transponders that customers like Cisco (Nasdaq:CSCO), IBM (NYSE:IBM) and Ciena (Nasdaq:CIEN) use in their data center and network equipment. As such, Finisar is not only a good play on data traffic growth and the increasing use of optical products in data centers, but also the recovery in carrier spending.

The Push-Pull of Competition
Although Finisar is a little larger than JDS Uniphase (Nasdaq:JDSU) and Oclaro (Nasdaq:OCLR), JDSU has a larger share of the ROADM and tunable XFP markets. New products at Finisar may shift some of that share, though. Finisar's new ROADM line cards sell for as much as two times more than modules, and it looks like the company is breaking into JDSU customers like Cisco and Ciena.

On the other side of the competitive fence, there are threats that Oclaro's merger with Opnext gives the company more operating leverage, and perhaps more opportunity to compete on price. Elsewhere, Cisco's acquisition of Lightwire creates at least the possible risk that Cisco will internally source more of its 100G component needs - a meaningful threat to Finisar given that 100G adoption/rollouts are a big part of the rationale for higher sales and profits in the coming years.

SEE: Biggest Merger and Acquisition Disasters

More Spending at Last?
Analysts and investors have been waiting for some time now to see an increase in carrier spending. While AT&T (NYSE:T) has guided to more capex spending in 2013 (including 100G) and Verizon (NYSE:VZ) too seems to be devoting more resources in that direction, there's an element of "we'll believe it when we see it" to these projections. It's true that carriers eventually have to build out capacity, but finding specificity on the timing and amount has proven to be something like nailing Jell-O to a tree.

On the data center side, Finisar should be looking forward to an upgrade cycle to 10Gbps products. I say "should" because major data center providers have all pointed to a slowing in spending and cautious customers. Here too it is probably a "when, not if" upgrade cycle, but waiting on that "when" can be frustrating for investors and difficult for the stock price.

SEE: A Primer On Investing In The Tech Industry

How Good Can the Good Times Be?
Finisar's datacom business has held up pretty well even while telecom spending has been soft. Unfortunately, this is a company that has only reported positive operating margins three times in the last 10 fiscal years and positive free cash flow (FCF) three times as well (and not in the same years). Suffice it to say, that makes modeling the margins and FCF in the coming years more of an exercise in guesswork than is typically the case. With the company having also reduced the transparency of its reporting (giving less product/segment detail), this is not an easy model to build and that increases the risk of this stock.

The Bottom Line
If Finisar can post a peak recovery FCF margin in the low teens, fair value on these shares is likely in the mid-teens. Boost that peak into the mid-teens, though, and the fair value climbs into the high teens and the shares look more compelling. Admittedly, this is a lot of guesswork at this point, and it's worth noting that today's EV/revenue multiple of 1.3 times could easily move past 2.0 times (or higher) once the Street is convinced that the recovery is on.

Consequently, while this is a stock with above-average risk and very uncertain fundamental value, I do believe that, as in the case of Ciena, an argument can be made that these shares will outperform if and when that carrier spending recovery materializes.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  2. Investing

    Will Facebook's New App Leave Siri in the Dust?

    Currently Facebook is testing its new super intelligent virtual assistant, known as, "M". Can this new AI on the block dethrone Apple's Siri?
  3. Investing

    YouTube Red vs. Netflix vs. Spotify

    YouTube Red offers a unique and compelling combination of ad-free video and music streaming.
  4. Stock Analysis IPO: Is it a 'Buy' or Should You Pass?

    Demand for relationships is always high. Now you will have a way to directly invest in the relationship market. But is it priced fairly?
  5. Stock Analysis

    If You Had Invested in Qualcomm Right After Its IPO

    Find out about how much you would have if you had bought 100 shares of Qualcomm during its initial public offering and the amount you would receive in dividends.
  6. Mutual Funds & ETFs

    3 ETFs That Invest in Semiconductors

    Obtain information on three of the most widely traded ETFs that investors utilize to gain investment exposure to the important semiconductor industry.
  7. Fundamental Analysis

    Yahoo, Google Back Together in Search Deal

    Google and Yahoo have signed a search deal yet again. The question is whether this one will stick.
  8. Stock Analysis

    Is Apple Overreliant on China?

    Apple's fourth quarter was more sweet than sour. But will that story hold true next year if China suffers another stock shock?
  9. Stock Analysis

    Samsung Vs. Apple: Comparing Business Models

    Read an in-depth review of competing business models in the tech industry, including how Apple and Samsung are redefining corporate warfare.
  10. Investing

    How Does Paribus Work and Make Money?

    Paribus gets costumers money back on their purchases after the fact, using the same algorithms that retailers use to manipulate online buyers.
  1. What happens if a company's earnings fall short of estimates?

    Companies try very hard to not miss their earnings estimates, but it does happen from time to time. These missed earnings ... Read Full Answer >>
  2. How can I access a company's earnings report?

    One of the most important tools in the arsenal of the fundamental investor is the company earnings report. The earnings report ... Read Full Answer >>
  3. What is the difference between earnings and income?

    The differences between earnings and income change depending on the context. Technically speaking, personal earnings are ... Read Full Answer >>
  4. Why does Warren Buffett largely avoid investing in the technology sector?

    Warren Buffett has often said that he avoids investing in the technology sector because he does not like to own stocks in ... Read Full Answer >>
  5. How does a share premium account appear on a balance sheet?

    A share premium account shows up in the shareholders’ equity portion of the balance sheet. The share premium account represents ... Read Full Answer >>
  6. What are examples of popular companies in the Internet sector?

    There have been a number of financial fortunes created by highly successful Internet companies. Some of these firms, such ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center