Cisco's (CSCO) recent deal to buy privately-held Lightwire is a clear negative for Finisar Corp. (NASDAQ:FNSR) as it would affect the fastest growing revenue stream of Finisar.
Cisco Systems Inc. (NASDAQ:CSCO) said that it intends to acquire Lightwire for about $271 million in cash, to strengthen its optical connectivity business. Lightwire is known for its development of CMOS-based (complementary metal–oxide–semiconductor) optical communication technology. Lightwire's development efforts have been focused on the high-speed connections between routers and switches in data centers.
The acquisition is considered as key to Cisco as it would help the networking gear maker deliver cost-effective, high-speed networks catering to the growing demands of video, data, voice, mobility and cloud services. The deal would build on Cisco's 2010 acquisition of CoreOptics.
Through Lightwire, Cisco targets reducing the cost of transceiver modules in higher end platforms through the use of CMOS Photonic technology. In the past, Cisco acquired module or sub-module companies (e.g. CoreOptics) when it sees value in incorporating the technology onto products.
The acquisition would hurt Finisar, which supplies components and subsystems specializing in transceivers and other optical modules and one of Finisar's biggest customers.
"We're concerned about Cisco's acquisition of Lightwire, as it presents the potential for Cisco to adopt proprietary interfaces for 40G and 100G optical interconnects in lieu of Finisar's solutions," Jefferies analyst James Kisner wrote in a note to clients.
Kisner said his checks indicate that Cisco plans to launch proprietary interfaces (in lieu of those provided by Finisar) for high-speed (40G/100G) interconnects using Lightwire technology by July 2013.
Lightwire's technology is predominantly part of the "silicon photonics" field whereby discrete optical components/functions are integrated into a semiconductor substrate, thereby providing a number of opportunities for cost savings.
Lightwire's technology offers the potential to leverage high-volume semiconductor manufacturing processes in lieu of less automated optical manufacturing processes. As a result, Lightwire's technology is said to be potentially very disruptive, reducing the cost of 100G solutions by 90 percent while increasing platform density.
"We estimate that only 5-10 percent of Finisar's current revenue is at risk as a result of the Lightwire acquisition, but we're concerned that this portion of Finisar's revenue stream is among the fastest growing," said Kisner, who downgraded Finisar shares to "hold" from "buy."
Infonetics predicts that 40G/100G will comprise 44 percent of the short and intermediate reach optics markets by 2015 versus an estimated 29 percent in 2011.
It is a bit difficult to explicitly quantify the risks that Cisco's Lightwire acquisition poses to Finisar. Cisco was a 22 percent customer in fiscal 2010 and a greater than 10 percent customer in fiscal 2011. In theory, all of this revenue could be at risk.
Currently, Cisco would be more focused on leveraging the technology for 40G and 100G optical interconnects. The analyst expect roughly 10-15 percent of Finsar's total company revenue comes from 40G/100G applications for the data center, and perhaps half of that (5-8 percent) is Cisco 40G+100G.
"At a minimum, however, we expect that the technology risk presented by silicon photonics is likely to be an overhang for Finisar shares, particularly as investors become more aware of it," Kisner said.
Though there is clearly significant uncertainty around Cisco's ability to successfully integrate Lightwire technology, this issue could become more prominent in investors' minds at the OFC optical industry conference to be held in Los Angeles on March 5.
"At this point, we'd rather see investors rotate into JDSU (JDS Uniphase) given its relatively greater exposure to rebounding service provider capex," the analyst added.