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. Fundamental Analysis

    Rise of Netflix Making Nielsen Ratings Obsolete

    Netflix is a major disrupter of traditional television programming production and distribution. The once all-powerful Nielsen ratings must adapt or become a relic.
  2. Stock Analysis

    The 4 Technology Stocks You'll Wish You Bought in 2015

    Find out which technology stocks you wish you had bought in January 2015, including such big names as Amazon.com, Netflix and Electronic Arts.
  3. Term

    Why You Should Consider Investing In the Tech Industry

    The technology industry offers huge investment opportunities.
  4. Investing

    No Solace in Small Caps

    In the U.S., second-quarter earnings season has generally been better than expected. However, it has failed to inspire investors.
  5. Stock Analysis

    Netflix's Future Growth: Greater Than You Think?

    The potential for Netflix could be considerably greater than you think.
  6. Investing

    Can You Be Sued for Negative Comments Online?

    It's important to understand the basics of libel law so you can avoid posting statements that might result in a lawsuit.
  7. Investing News

    How China's Lenovo Makes Money

    Lenovo has emerged as one of China's most renowned multinational corporations. We examine the strategy and business model underlying its success.
  8. Investing Basics

    Is Lenovo A True Disruptor Of The Laptop Industry?

    Lenovo has cut costs, taken market share from top competitors and caters to both consumers and institutions, but is it a disruptor?
  9. Trading Strategies

    Microsoft's Game of Catch-Up With The Dow

    Microsoft (MSFT) underperformed the Dow Jones Industrial Average during the 2002 to 2007 bull market, but it has played catch-up in recent years.
  10. Fundamental Analysis

    Burger King and Tim Hortons Are Better Together

    In August 2014, 3G Capital announced that it was merging Burger King with Canadian coffee chain Tim Hortons to form Restaurant Brands International.
RELATED TERMS
  1. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  2. Virtual Good

    A good or product traded in the non-physical realm, typically ...
  3. Chief Technology Officer - CTO

    An executive who is responsible for the management of an organization's ...
  4. Dotcom Bubble

    An rapid rise in equity markets fueled by investments in internet-based ...
  5. Bleeding Edge Technology

    Technology that is acquired almost immediately after its release, ...
  6. Triple Play

    In investments, a stock that simultaneously beats analyst expectations ...
RELATED FAQS
  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

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!