|Shares Out. (in M):||20||P/E||19||17|
|Market Cap (in $M):||1,900||P/FCF||30||22|
|Net Debt (in $M):||-30||EBIT||137||154|
|Borrow Cost:||Tight 15-50% cost|
negative revision to outlook on earnings call 8/3
Market share loss at leading datacenter customers becomes manifest (this has occurred, but is not yet acknowledged by the sell side)
|Subject||Questions on timing|
|Entry||08/02/2017 12:28 PM|
Thanks for the writeup. Your divergent view is refreshing. Since AAOI just pre-released better #'s for 2Q17 20 days ago and reports their full 2Q17 tomorrow (along with 3Q17 guidance), what makes you think that they will give a bad guide for the 3Q17 to coincide with your variant perception? Or do you think they will guide well and then just miss miserably? Have you heard of the vendors accelerating their 100G launches in August/September? What is their stated timeframes for 100G adoption?
And do you expect an equity offering in the near term to help fund their capex spend and inevitable losses?
Any other vendors besides MTSI (which is down 20% today) get hurt from this move?
|Subject||Re: Questions on timing|
|Entry||08/02/2017 12:48 PM|
Thanks Repetek. My view on Q3 is predicated on a few factors. To answer your questions in order:
1) Yes, it is unorthodox and "bad form" to guide poorly following an upside pre. However, the language in the press release does not allude to continued strong momentum as did the preannouncement PRs in April (for Q1) and January (for Q4). In my opinion, management will issue a soft guide that they will then miss. They will blame the softness on a transition period between 40G and 100G to placate bulls.
2) Luxtera in particular has been aggressive, meeting with investment banks in recent quarters as they attempt to go public on the 100GBe Amazon business they have won. MA/COM and Fabrinet have also done the unusual step of disclosing the whitebox relationship with Amazon before it ramps beginning in Q4. At the very least, AMZN procurement of 100GBe from AAOI will be very low volumes compared to 40GBe volumes as they have at a minimum three sources of supply. Pricing on 100GBe PSM4 is also already below 40GB and is dropping further, while costs to produce 100GB are much higher.
We also believe that after very strong H1 capex from MSFT and AMZN, 40GB procurement will be down sequentially. This jibes with what we have been hearing from 40GB ethernet switch and NIC suppliers for some time, that 40 is "done" and 100 will be the vast majority of business going forward.
The one account that is set to grow in Q3 for AAOI (FB) is dwarfed by the two (MSFT, AMZN) that should be down in Q3.
3) AAOI used an at the market offering to raise $50m last year and this year and management would certainly be foolish not to do the same this time around.
|Subject||Re: Questions on timing|
|Entry||08/02/2017 12:54 PM|
As for your last question as to other vendors, the competition and looming overcapacity in 100G is a negative for the whole industry. However AAOI is the only vendor disproportionately exposed. FNSR also has high exposure but with offsets in 3D Sensing. As you noted MTSI is down a lot however I concur completely with the bear case written up by another member and there is further downside to at least the mid $30s there over the coming year.
ACIA and OCLR are also shorts in my opinion, although the quarterly expectations game is tough to call with these stocks because they have already cut numbers. Ultimately we are talking a capital intensive commodity business that is intensely cyclical. Traders are hyper datapoint focused right now but in the big picture, 1x sales is what we should pay for these stocks and they all sell at 2-4x.
|Entry||08/03/2017 04:49 PM|
I appreciate you posting this idea. Thanks. Easiest (because you did all the work) short I've had in a long time.
|Subject||Re: High five!|
|Entry||08/03/2017 05:01 PM|
Thx. Having gotten owned on shorts all year feels good to get the timing right on one....
|Subject||Re: Re: High five!|
|Entry||08/03/2017 05:10 PM|
Worth noting that management has just guided capex to 85m ($4.20 per share), implying that 2017 despite being a peak revenue / margins year will also see negative free cash flow. There is no floor here.
|Subject||Re: Re: Re: High five!|
|Entry||08/03/2017 06:06 PM|
Great call on nailing the timing here. That's the hardest part in these names, and you did it extremely well. Congrats.
|Subject||Q3 and Q4|
|Entry||08/12/2017 03:01 PM|
Congrats on this! They guided Q3 revenue in the range of $107 million to $115 million. Do you think they will dissapoint even vs. that number and deliver your estimated $95 million in Q3 and $80 million Q4?
|Subject||Re: Q3 and Q4|
|Entry||08/12/2017 03:32 PM|
Thanks! I believe visibility is swiftly deteriorating for AAOI and competition is rapidly increasing. On their conference call last week Lumentum talked about trends getting worse in 100G datacom on price competition in CWDM4, the exact product AAOI is depending on in 100G as they have lost virtually all share on PSM4 to the silicon photonics vendors. Lumentum also grew its 100G datacom business by 100% sequentially, compared to about 50% q/q growth at AAOI.
Given the rapidly deteriorating conditions, I certainly believe AAOI will deliver, in the best case, revenues at the low end of Q3 guidance. Meanwhile, the 40G order cuts are likely to only get worse in Q4 as 100G supply is now adequate for the hyperscale CSPs to transition entirely to 100G. I stand by my assessment that revenues in Q4 should approach the $80 million level with only marginal profitability delivered as gross margins return to the low 30s (or lower).
Ultimately, gross margins likely trough substantially below 30% as with the exception of the recent 5 quarter upcycle, AAOI's datacenter gross margins were in the high 20s despite a much more benign competitive landscape in 40G than 100G. When evaluating margins and profits we also have to keep in mind the suspiciously high levels of capex at AAOI, which are serving to completely erase free cash flow and raise the specter of improper cost capitalization.
|Subject||Raymond James Site Visit|
|Entry||08/15/2017 01:30 PM|
AAOI hosted a site visit today (replay available on the website). To me the incremental disclosures were:
1) AAOI committed only to "aggregate volume growth" on 100G transceiver in Q3, not revenue growth. This is very worrisome since 40G is in a secular decline, and implies heavy pricing pressure (and that Q3 is likely to miss expectations).
2) AAOI would not comment on Amazon ramping volumes in Q4. Previously, they have been willing to give granulairty on customer ramp timing.
3) AAOI admitted to carrying "some amount" of 40G inventory, though not so much they think margins are jeopardized. This seems like wishful thinking.
4) AAOI was open that pricing in 100G is very aggressive. They think they can hold margins 41 - 45% despite this, but it's unclear how they plan to do that.
5) AAOI talked about getting into silicon photonics, and admitted it is the best solution for certain customers and applications. They plan to have initial products to sample in 1H 2018. To me this is an admission of weakness as they have previously insisted their existing production process using MBE is the most cost effective. Even if they execute on pivoting into silicon photonics, this is at best a 2H 2018 revenue story.
|Subject||Oclaro listed Amazon as customer in 10-K for first time, filed Friday PM|
|Entry||08/21/2017 10:09 AM|
Obviously, not a good thing for AAOI.
|Subject||Any idea on why the stock is soaring the last two days?|
|Entry||09/19/2017 01:44 PM|
|Subject||Re: Any idea on why the stock is soaring the last two days?|
|Entry||09/19/2017 04:07 PM|
Two factors: 1) borrow has gotten extremely tight, rebate isup and float was 71% short as of month end, so there is clearly some rocket fuel for a squeeze. 2) Google is upgrading its datacenters to 100 / 200G in 2018 and AAOI is rumored to be bidding on the business. This is not a surprising development (why would Google not want to create a competitive environment as it chooses suppliers and sets pricing), and I am not particularly optimistic on AAOI's chances of winning a substantial share of GOOG's business given the intense competitive landscape, and GOOG's equity investment in Innolight (the primary supplier to GOOG 40G builds). However, that did not stop Cowen from highlighting Google's RFP as a "significant potential positive" for AAOI.
Perhaps the real question of interest is why did AAOI choose to skip the European optical conference this week when all of its competitors were in attendance, and why did AAOI not present at the annual Roth datacenter conference in Laguna this year when again, many of its competitors were in attendance (including Luxtera) and it has gone in years past?
I view this spike as a good opportunity to initiate or add to short positions in AAOI ahead of significant downward revisions to Q4 and 2018.
|Subject||Re: Re: Any idea on why the stock is soaring the last two days?|
|Entry||10/12/2017 04:44 PM|
Fantastic call. Seems like this is playing out as predicted. Would love to hear any updated thoughts on name or tangential thoughts.
|Subject||Re: Re: Re: Any idea on why the stock is soaring the last two days?|
|Entry||10/12/2017 05:01 PM|
Agree, excellent call so far. Obviously revenue down is the big red flag kahuna but the sustained gross margin is still a bit surprising. I'm leaving that for the actual earnings release as it's much easier to fudge margins than it is revenue. This looks to be destined to return where it came from. Bravo
|Subject||Re: Re: Re: Any idea on why the stock is soaring the last two days?|
|Entry||11/05/2017 11:13 AM|
Thanks tyler. The thesis is indeed playing out as predicted and even faster than predicted in the case of AMZN implosion, which I had been assuming would play out more gradually. It appears that AAOI relentlessly overshipped in H1 yielding an inventory glut that caused a sharp cliff in the AMZN 40G business rather than a multi-quarter taper I had predicted.
Fundamentals continue to deteriorate in the optical group broadly and for AAOI specifically. Oclaro and Lumentum both commented last week that datacom optics trends are worsening, with pricing becoming so aggressive as to make LITE question its commitment to the space. Meanwhile, OCLR is now debating taking its high spec products downmarket to compete in the CWDM4 datacom optics space where AAOI is an aspirational player (their real bread and butter is 40G PSM4, which is going away in the coming quarters).
AMZN cliffed from mid $50s million to <$10 million in one quarter and is not going to be coming back as they are done with 40G builds, have excess inventory and AAOI has minimal share of 100G where pricing is also worsening rapidly. FB and MSFT are the next shoes to drop, FB because AAOI lost share there to Colorchip and Intel recently and MSFT because its 40G builds are soon to ramp down a la AMZN. This will cause another $30 million of revenue to come out of the AAOI model in Dec / Mar Qs.
Margins hung in in Q3 due to the vertically integrated model (production was high making unit costs low in Q3) but this will turn to a headwind in Q4 and 2018. As I mentioned, the suspiciously high capex at AAOI also begs the question of whether improper capitalization is occurring.
I estimate AAOI can generate somewhere on the order of $250 - $300 million of revenue in 2018 with minimal profits and likely negative free cash flow. Valuing the stock at .5 - 1.5x revenues yields a range of about $7 - $20 as fair value.
Again, the rebate is high, it is a crowded trade and who knows what management may try to say or guide to juice the stock, but facts on the ground bear out a further 50% downside from these levels.
|Subject||Re: Re: Re: Re: Any idea on why the stock is soaring the last two days?|
|Entry||11/08/2017 08:55 AM|
Q3 quick takes:
In addition to 40G revenue declining by 50% q/q 100G rev was down 5% q/q in a quarter where the 100G datacom market grew double digits sequentially for peers, showing that AAOI lacks competitive positioning in 100G.
AAOI burned 17m of cash in the quarter with inventory days rising to an all time high and nearly 2.5x historical averages, yet claim they won't have to price aggressively to move the inventory which is "mostly 40G" legacy product.
The guidance of 80 - 90m, 41 - 43% GM and increasing opex would be a roughly $.65 guide ex one-time tax benefits meaning AAOI is at a $2.60 run rate despite not capitulating on the fact that they have lost meaningful share at FB in addition to AMZN.
AAOI implied Q4 guide for capex suggests the company will have another high-teens burn quarter in Q4 despite income statement profits.
MSFT and FB next shoes to drop likely in late Q4 / early Q1 triggering another round of downward revisions.
Some short covering AH due to the fact that the guide wasn't the massive capitulation some hoped for and the rebate is high, but nothing in the quarter was fundamentally positive. The datacom optics market is massively oversupplied and next year is going to be ugly. Street EPS is shaking out to be $3.00 - $4 this morning for 2018 despite relying on optimistic assumptions from management, down from $4.60 last night.
|Entry||02/06/2018 05:44 PM|
Thor25, are you still following AAOI? Anything new? Thanks.
|Subject||Thor, once again, great call.|
|Entry||02/22/2018 08:56 AM|
|Subject||Re: Thor, once again, great call.|
|Entry||02/22/2018 11:14 AM|
Thanks Tyler, and Roc sorry for the late reply.
Updated thoughts: The results and guidance, while very poor, are still not final capitulation by any stretch. Most perplexing was management's guide for $109m of capex for 2018 as they ramp spending into an oversupplied datacom optics market (or, in a more cynical view, as improper cost capitalization kicks into ever higher gear). The implication is FCF will track to negative 15m to 50m depending on whether you use bull or bear sell side numbers coming out of the print, or (.75) - (2.50) per share while still in a relatively favorable part of the market cycle.
By my research, MSFT 40G builds are likely to ramp down significantly in Q2 / Q3 timeframe yielding incremental top line pressure of ~10m / quarter. Thus, revenue could eventually settle in around 60m / quarter with nominal to zero adjusted EPS and significant negative free cash flow at those levels.
In the short-term, the stock may find a tactical low given the 70% short interest and the potential for management to signal new design wins at OFC in early March (they are certainly not above disingenuous tactics to juice their stock, see the FB purchase framework they disclosed in an 8-k after the close last night to try to cushion the results, I have never seen a company do this before in this space...it reeks of desperation).
In my view, fair value is in the mid-teens assuming inventory, receivables and PPE can be liquidated at a 20% discount to book value. As a standalone company I don't see AAOI returning to sustained free cash flow generation through any reasonable modeling horizon.
Very busy today so apologies for the brief thoughts. After maintaining the short position size from $100 down to the mid $30s I am no longer pressing but not covering either.
|Subject||Re: Re: Thor, once again, great call.|
|Entry||02/22/2018 01:26 PM|
What I don't understand is how the gross margins have been sustained. I've long suspected they are capitalizing costs into CapEx or funny business with inventories, which is up over 40% YoY despite revs down. Any views on this, thanks.
|Subject||Re: Re: Re: Thor, once again, great call.|
|Entry||02/22/2018 02:28 PM|
I have suspected funny business in capex and inventories for a long time. There is little doubt in my mind that with DOI at 150 vs. 90 last year there are substantial mark-downs ahead. The improper capitalization issue of COGS into PPE is the more nefarious and potentially meaningful element at play (is AAOI treating parts of the transceiver production process as factory upgrades, for example, or capitalizing scrap into PPE). Anyway, we know that over time FCF doesn't lie and AAOI has none.
|Subject||Re: Re: Re: Re: Thor, once again, great call.|
|Entry||04/19/2018 03:13 PM|
Looks like retail is pumping this thing again, in an environment with 100G CWDM4 prices going lower and lower. FB could be a dud due to Intel crushing price and AMZN/MSFT are ramping down. I'm getting to under $50MM per Q in the back half, is this reasonable? Love to hear your thoughts.
|Subject||Re: Re: Re: Re: Re: Thor, once again, great call.|
|Entry||05/30/2018 03:44 PM|
Are you still involved? I am surprised at the move this month. It looks like mgmt might be pumping the stock ahead of a capital raise. They are running low on cash. We haven't picked anything new on pricing pressure. Gross margins for the back half have to come down for the short to work from here. While supply is being added, demand is also very strong with FB, GOOG et. al. announcing nearly 100% rise in Capex.