Denis_Dryashkin/iStock via Getty Images
Denis_Dryashkin/iStock via Getty Images
As most of you surely know, the current market correction has hit the technology sector especially hard. That being the case, the fact that Lumentum's (NASDAQ:LITE ) stock is still up almost 6% over the past year while the tech sector is down nearly 12% - as measured by the Invesco NASDAQ 100 ETF ( QQQ) - is quite impressive. That LITE has also outperformed the S&P500 over the past year is even more noteworthy (see graphic below). The reason for the out-performance is two-fold: not only has LITE's operational performance been solid despite many headwinds out of its control, but demand for LITE's optical components has been out-stripping supply. As a result, margins are healthy and with an estimated $1.1 billion in net cash, the balance sheet is rock solid. But the bottom line here is that LITE's 3-D sensors for front- and world-facing cameras are a hit, it is increasing manufacturing capacity to meet strong demand for its ROADMs optical networking product, and the future of high-end laser-based optical products is very bright. LITE is a BUY.
I've covered Lumentum's 3-D sensors for use in smartphones, as well as the company's ROADM ("reconfigurable optical add-drop multiplexer") optical-networking product in previous Seeking Alpha articles (see here and here). Both of those markets continue to show strong demand and have excellent long-term potential going forward.
Today, I'll focus more on Lumentum's pending acquisition of NeoPhotonics (NPTN) for $16/share in cash (note NPTN is currently trading at $15.36), which was announced in November of last year and is expected to close in the 2nd half of this year. As mentioned in the bullets, LITE had its previous attempt to acquire Coherent (COHR) thwarted by that company and received a $217.6 million break-up fee for the trouble. That goes a long-way in purchasing NPTN, which at $16/share equates to ~$918 million.
The addition of NeoPhotonics will add differentiated products, technology, and an innovative R&D team to Lumentum's already very strong presence in the optical networking component market for the cloud and telecom network infrastructure:
As can be seen by the graphic above, the addition of NeoPhotonics' expertise will greatly enhance LITE's ability to address the large and fast growing cloud and high-speed networking markets. The combination will improve LITE's expertise in the underlying technologies critical in addressing these markets with leading edge solutions. In addition, the two companies expect ~$50 million in run-rate synergies within 24-months of closing. The end result is a stronger and more diversified company that will have a broad array of products to address the high-speed networking market going forward - from the cloud-edge, to inside, and between cloud datacenters:
With that as background, let's take a look to see how LITE has been performing lately.
Lumentum announced its Q3 EPS report on May 4th and it was a beat on both the top- and bottom-lines and came in at the high-end of previous guidance. That said, yoy results were lower pretty much across the board:
As can be seen in the graphic, total revenue was down ~$24 million yoy with strength in the Commercial Laser segment not enough to overcome weakness in the Optical Communications segment. Gross margins were still relatively strong, though down sequentially and yoy.
Lumentum President & CEO Alan Lowe commented on the quarter:
Demand for our products continues to accelerate, and we now expect demand to outpace component supplies by more than $100 million in the fourth quarter. Our fourth quarter revenue is expected to increase from the third quarter, primarily driven by Telecom product shipments. I am highly optimistic about our outlook and believe market inflections beneficial to Lumentum in our addressable markets will drive double-digit revenue growth in fiscal 2023 and beyond.
On the Q3 conference call, Lowe gave investors an update on some of LITE's market dynamics. Some key takeaways from the call include:
On ROADMs, Lowe said that shipments have been significantly impacted by IC shortages and that:
... demand is extremely strong. And as the IC shortages improve and we're seeing it in Q4, ROADMs will increase as a result of that. So, a lot of pent up demand for ROADMs ... in a lot of cases, we're sole sourced in these advanced ROADMs. And customers critically rely on our technology and products for these next generation of networks. So ROADMs are very, very strong. I wish I had more ICs because I'd be able to ship a whole lot more in Q4 and beyond.
Meantime, LITE continues to add capacity for pumps that have constrained ROADM shipments in the past and as demand continues to outstrip the company's ability to deliver product. The company is also looking at plug compatible IC second sources so as not to have to re-spin printed circuit boards.
During the quarter, LITE spent $124.0 million to repurchase 1.3 million shares of stock. That equates to an estimated average of $95.4/share while at pixel time the stock is currently trading at $86.30. After boosting the share buyback program by $1 billion in March, LITE ended the quarter with $513.5 million remaining under the board-authorized share buyback plan.
LITE ended the quarter with cash of $2.6 billion and long-term debt of $1.45 billion, or a net-cash position of an estimated $1.15 billion. Based on an average of 74.5 million fully diluted shares outstanding at the end of the quarter, that equates to an estimated $15.44/share in cash.
Lumentum is not immune to the highly uncertain macro-environment - specifically, chip shortages as a result of strong global demand, under-capacity of the semiconductor industry as a whole, and pandemic related shut-downs and supply-chain disruptions. Not just as these factors affect LITE, but also how they affect the company's customers.
Meantime, the effect of Putin's horrific war on Ukraine, and the resulting sanctions placed on Russia by the United States and its Democratic and NATO allies have effectively broken the global energy and food supply-chains. This is causing high inflation and expectations for higher interest rates which could slow the global economy and/or cause a global recession.
Despite near-term and multiple headwinds, LITE continues to perform very well. Indeed, demand is so strong the company cannot ship enough product due to chip shortages and supply-chain constraints. However, the mid- and long-term potential of the Lumentum+NeoPhotonics combination is very bright in my opinion. Given LITE's strong balance sheet and high-cash position (an estimated $15.44/share), the company can easily afford the acquisition and I am quite surprised the NeoPhotonics is currently trading at such a large discount (3.8%) to the $16/share cash offer. After all, the deal should close relatively soon and despite all the hand-wringing about higher rates, the 10-year Treasury is currently trading at 2.77%. Seems like a decent arbitrage play to me.
Regardless, here's the bottom line: LITE currently trades with a forward P/E of only 14.3x. Meantime, SA reports there is a rather large short position outstanding (13%) despite the company's strong cash position and demand out-stripping supply. My instinct tells me that LITE is going to deliver strong earnings reports over the next couple of quarters and that will force the shorts to cover. However, even if that does not happen, I still rate LITE a BUY with a 12-month price target of $115 based on a FY23 adjusted earnings estimate of $7/share. That equates to a relatively conservative 16x multiple and the potential for a 12-month gain of 30% plus. Note that LITE was trading ~$108/share back in January.
I'll end with a 3-year price chart of LITE stock versus the S&P500 and triple Qs:
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an electronics engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.