Gilder's Guidance

04/14/2006 12:00 am EST

Focus:

George Gilder

Founder and President, Gilder Publishing, LLC

There are few advisory services as intelligently written and consistently valuable to sophisticated technology investors than the Gilder Technology Report. Here, George Gilder and analyst Charlie Burger look at the prospects for Finisar.

"Since adding Finisar (FNSR NASDAQ) to the Gilder Technology Report 'Telecosm Technologies' list last December, the stock has more than doubled. Is it still a good value? The #2 optical components supplier behind JDS Uniphase, Finisar generates 90% of sales from optical transceivers. The company ranks #1 in SANs (storage area networks), #2 in LANs (local area networks), and has a growing MAN (metro area networks) business.

"Cisco is Finisar's largest customer, and Finisar in turn is the largest optical supplier to Cisco. April should bring the eleventh consecutive sequential revenue rise, hoisting sales for fiscal year 2006 to $362m, up 29% from 2005 and double 2004. Online applications are sending the SAN market into orbit. Brocade, EMC, and QLogic plan to double the size of their installations over the next year and continue to add at a compound annual rate of 70% thereafter.

"The uptake of 4 Gbps networks accelerated unexpectedly the last few months; Finisar sold out of 4 Gig optics last quarter and expects that by year's end sales of 4 Gig will surpass 2 Gig. At about that time, 8 Gig should launch. Online apps are also pushing 10 GigE into LANs and MANs. Revenue from 10 Gig more than tripled over the year-ago quarter to $5 million. This merely scratches the surface of the long-term opportunity-Ethernet ports in the last mile- have been growing 20-30% annually, with 10 Gig still only a small fraction of that.

"Also benefiting Finisar, telecom is moving from fixed to pluggable optics, apparently in short supply. A Finisar forte, pluggable transceivers give integrators greater flexibility in designing line cards compared to the traditional method of soldering in components supplied by myriad vendors. Finisar is also the largest supplier of VCSELs (vertical cavity surface emitting lasers). Using a unique process, Finisar grows the lasers on top of a photodetector, enabling precise readings and low power for optical mice. Logitech is selling out of these mice in Europe, limited by Finisar's ability to supply the lasers. The company is investing heavily here, and Logitech has committed to shipping every VCSEL Finisar makes.

"Cisco is cutting its optics suppliers to seven next year, and Finisar is on the short-list. Other systems houses are following Cisco's lead, looking for volume pricing and closer ties to suppliers. Fewer rivals in a growing market means Finisar should more than make up in volume what it loses on price. Though its factories are running 24/7, Finisar believes it can support many times today's sales simply by adding and adapting equipment. With manufacturing humming, added equipment brings a quick payback, and every dollar of new business generates 40-50% margins.

"For fiscal year 2007 beginning in May, management forecasts some $430 million of revenue with a pro-forma EPS of $0.15. During the first half of the year operating margin should ascend through the 10-13% range, reaching the long-term goal of 15% thereafter. Helping operations is gross margin, improving from 22% to 34% since last April through economies of scale and better processes.

"The company thinks it can grow 20% over the next few years. At that rate, sales would reach $512 million in fiscal 2008. Assuming a 15% operating margin and no taxes, we estimate an earnings per share of $0.21 or 40% higher than next year's forecast based on the 370 million shares management anticipates will account for potential dilution from converts. At a p/e of 40, that comes to $8.40 per share. Thus the path to the next double should be tougher and longer. But Finisar has significant upside potential and downside protection."

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