Tax Reform 2018 Update 2


Our investment thesis still holds:  AAOI will return to its pre-earnings price in Q4 and 2018 Q1.. Given the stock's tendency to post big daily moves you buy on the DOWN days. 

As we have stated before, AAOI is a multi-year growth story and the current concerns around their admittedly large customer Amazon is l unnecessarily short-sighted.

YES The growth narrative is pausing in Q3 due to 40G laser fall-off outpacing 100G ramp and Amazon sales weakness as they ramp to ALL 100G laser networking in their AWS Cloud.

We KNOW this pause is temporary and somewhat expected considering the transition away from 40G and towards higher data rates. In Q4, 100G demand ramp will outpace 40G fall-off, and the growth narrative will resume.

Moving past the near term noise, AAOI is really a growth story at the 100G and up data rates. It really sounds like the 200G and 400G growth stories will be just exciting as the 100G growth story has been, and that means robust demand for AAOI product will continue over the next several years.

As companies shift towards higher and higher data rates over the next several years, that will: 1) highlight AAOI's low-cost leadership position in the market and allow the company to grab more market share, and 2) grow gross margins as higher data rate product usually carries with it higher margins than lower data rate product.

Meanwhile, the company continues to broaden its customer base and diversify its revenue streams. That puts the company less at-risk to sometimes erratic one-customer spending habits (read Amazon).

Here is the opto research firm I follow on this space Light Counting. LightCounting expects 2018 100G data center optical transceiver demand to double or triple and recently raised its 2017 forecast by 20%.

The upside for 2017 suggests a robust outlook for Applied Opto when it delivers all important 4Q guidance in early November and justifies the current capex surge for 2018 capacity.

On Thursday, October 5th, LIGHTWAVE Online published a very interesting (and relevant to Applied Opto (AAOI)) story on a recent market research forecast by LightCounting, a credible optical industry market research firm. Feel free to look up both entities and check out the bios on the principals/analysts at LightCounting.

You might also want to bookmark the sites for future news and reference.
Here is the link to the story:
Data center appetite for 100GbE optical transceivers increasing: LightCounting
As the story is short, I will copy it here and provide commentary below:
Data center appetite for 100GbE optical transceivers increasing
October 5, 2017
Author Stephen Hardy
Editorial Director and Associate Publisher

While demand for optical transceivers from Chinese systems houses continues to disappoint (see, for example, "NeoPhotonics blames slow China demand for upcoming layoffs"), cloud data center operators may pick up the slack for some vendors, reports LightCounting.

market research firm says it now expects shipments of 100 Gigabit Ethernet (100GbE) optical (transceiver) modules to reach 3 million units in 2017, an increase of 20% over its previous forecast.

The fact that optical transceiver vendors have added production capacity helps explain the jump; 100GbE optical module sales in 2016 suffered when demand exceeded supply in many cases. However, appetite among data center operators for such modules will remain strong. LightCounting says that leading 100GbE customers plan to double or triple their purchases in 2018.

LightCounting notes its forecast methodology includes correlation between the growth rates of the aggregated bandwidth of optical connections within data centers and the data center traffic. Amazon, Facebook, and Google report that traffic in their mega data centers increased more than 100% in 2016 and will likely continue to do so in 2017, says the market research firm.

LightCounting adds that its research into shipments of optical transceivers to these operators is consistent with close to a 100% annual growth in traffic.

As to potential demand for optical modules that support transmission rates greater than 100 Gbps, LightCounting says its crystal ball remains cloudy. For example, the analysts note that Google has come out in favor of 200GbE, particularly in a 2x200GbE module format. However, Microsoft and Facebook have said they prefer going straight to 400GbE; indications are that Amazon feels the same way.
Here is what is relevant to Applied Opto:
The LightCounting 2017 100G data center optical transceiver demand forecast just increased by 20%. AAOI shares have been riddled with FUD (fear, uncertainty, and doubt) since the 2Q2017 results call that included some concerns relative to 3Q2017 guidance due to a faster than previously expected transition to 100G from 40G by Applied Opto’s largest customer Amazon (AMZN), with Applied Opto having a temporary mismatch to the new forecast in its factory. 4Q2017 guidance is going to make or break the stock in a big way.

Applied Opto stated in its 2Q2017 results call that it is accelerating the transition to 100G from 40G as it expands overall capacity. The LightCounting forecasts suggest demand will be quite solid for whatever 100G product Applied Opto can get out of its factory in 4Q, including to Amazon as it is the largest buyer in this increasingly robust market forecast.

At 10.4X the 2018 consensus EPS estimate of $5.57 and 8.3x my 2018 EPS estimate of $7.00, there is no doubt that AAOI investors do not currently believe these earnings projections are achievable, especially considering Applied Opto’s long-term CAGR of 40% suggests a higher stock multiple is warranted.

The consensus revenue growth forecast for 2018 for Applied Opto is a paltry 17% (to get to $5.57 in EPS) while LightCounting is projecting a double or triple in 100G-market demand in units. 

Clearly, there will be price reductions; but 100-200% unit growth for the market plus the addition of over a dozen new customers and likely initial sales into new segments (2km+ DCI) for Applied Opto suggest the 2018 consensus is way wrong on the low side, in my view.

Key Point: All in all, the growth narrative now actually looks more promising than the one before the Q2 report. One-customer reliance is a problem (Amazon write large) but that's being fixed. Meanwhile, the long-term revenue and gross margin narratives are better than they have ever been due to demand ramp at higher data rates.

So now let's talk valuation. AAOI stock now trades around 8.4x FY18 EPS estimates. That is a low multiple for a growth stock with a projected earnings CAGR of 18% over the next 5 years. There really isn't much reason that a stock with this robust of growth potential should trade at such a discounted valuation. That is especially true considering there aren't any problems on the balance sheet.

Consequently, we think AAOI stock can and will head materially higher, even after today's big move. We still like AAOI stock both in the near and long term.

Action to Take: THESE momentum trader sell-offs usually take 2-3 trading days to clear...this is day one.Tomorrow let's buy under $45 and get the bounce OVER $50 when the momo money is out and the shorts will HAVE to cover.

The CLEAR support for AAOI is $56. This puppy is MONSTEROUSLY oversold. 


Finally...look at our other guidance monster THAT WE PUT as a HOLD has come back from the dead! Ambarella...AMBA...its turns out now they are the ONLY Computer Vision semiconductor firm left to buy (GM just bought a LIDAR semiconductor company with no revenues for $1 billion fyi) and drone growth is re-accelerating. Buy Under $54 with $65 target 2017


OK?  Meanwhile almost ALL our core positions are hitting all-time highs or 52-week highs and our updated portfolio return for 2017 is now 51% and change and since 2016 has jumped to 126%.

Action to Take: Let's put BDCL on hold and see if it holds $17. It's paying us of course almost 21% annually to hold no rush. Small and large bank lending is NOT growing near what we would like...that is the weakest part of the recovery. But our cost basis is so low on BDCL at $15.10 (and really about $13.22 minus the dividends paid) that we have plenty of time to wait this out.

Of course we WANT to see this 2X leveraged ETN get aback above $18...but again we get paid to wait. 


That is all. October Newsletter percolating...LOTS of new positions to take and some to trim. MANY of our posiitions are over bought here (almost everyone actually) so sit back , let the profits role in and make SURE you have renewed your subscription if you are on our naughty list of unpaid subscribers who are opening our newsletters and alerts >70%!

Just click here and sign-up. IF you are a currently paid subscriber you have to renew and pay the $97...and you need a new user name and password of at LEAST 8 characters. We will add any unused portion of your previous subscription to your new one as soon as possible (our web vendor is working on it since we are the TOP of their good customer list!) 

Cheers! Toby


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