Coherent: Strong Datacom Transceiver Demand on the Back of Nvidia
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Summary:
Strong Financial Performance: Coherent exceeded fiscal Q4 2024 expectations with a 9.1% YoY revenue increase, driven by robust demand for AI transceivers.
Datacom Leadership: The company continues to lead in the datacom sector, particularly in the development and deployment of 800G and 1.6T transceivers, essential for AI and ML applications.
Strategic Focus and Debt Management: CEO Jim Anderson is strategically focusing on high-growth segments while divesting non-core businesses to manage the company's significant debt burden effectively.
Coherent (COHR) reported fiscal 42 2024 results that exceeded expectations with a 9.1% YoY increase in revenue to $1.31 billion, surpassing the predicted $1.28 billion. Adjusted earnings per share stood at $0.61, slightly above the consensus forecast of $0.60.
The company anticipates revenue for the first quarter of fiscal 2025 to fall between $1.27 billion and $1.35 billion, with adjusted EPS projected to range from $0.53 to $0.69.
Coherent reported strong performance in the Datacom sector, specifically on sales of AI transceivers. Optimism over the strategic approach of CEO Jim Anderson to enhance profitability and focus on high-growth segments resulted in several price target upgrades from Benchmark, Rosenblatt Securities, Morgan Stanley, and Citi.
CEO Anderson is also making strategic moves to divest non-core and underperforming businesses, as he attempts to reduce the massive debt from the $7 billion acquisition of Coherent by II-VI in 2022 and causing a Total Debt to Equity MRQ of 82.59%.
Datacom
Coherent, through Finisar, has been the leading manufacturer of optical network transceivers for the past 22 years.
According to the company’s 10-K:
“Today, more than 50% of Coherent’s datacom revenue is generated by 200G and higher data-rate transceivers. Driven by the demands of growing AI/ML adoption, 800G transceivers are shipping in production and we expect the first 1.6T transceiver samples will be shipped later this calendar year. In five years, the market opportunity for 800G and 1.6T datacom transceivers is expected to be greater than all other types of datacom transceivers combined, largely driven by AI and ML.”
As the data center switch market is migrating to 800G (Gps), Coherent is introducing transceivers that will form the core of the second generation of 800G transceivers and the first generation of 1.6T transceivers.
Growth in sales of Coherent’s Ethernet transceivers will grow as Ethernet replaces InfiniBand Networking Protocols. The Datacenter is included in the companies Communications Market, which increased from $616 million in fiscal Q3 to 678 million in Q4, exhibiting a 10.1% QoQ growth, as shown in Table 1. The 40.5% growth by the Electronics segment was due to silicon carbide production problems in Qs, in addition to a slowdown in silicon carbide because of slow EV sales outside China.
The Datacom Segment in the Communications Market is the focus of this article.
Datacom Optical Modules and Coherent
While 400G Ethernet optical transceivers are used predominantly in hyperscale data centers, and many enterprise businesses are currently operating on 40G or 100G, data center connectivity development is already moving towards 800G.
Table 2 shows the leadership from Coherent, initially from its acquisition of Finisar. In 2023, Coherent dropped to number 2.
Datacom optical modules, also known as data communication optical modules, are transceiver devices used in data communication networks to transmit and receive data over optical fiber cables. These modules convert electrical signals into optical signals and vice versa, enabling high-speed and long-distance data transmission.
At the cutting edge of datacom technology, the latest development is the emergence of 800G optical modules. These modules offer significantly higher data rates and bandwidth compared to previous generations, allowing for faster and more efficient data transmission in data centers and high-performance computing environments.
Although 70% of the world's top ten manufacturers of optical modules are from China in 2023, the localization rate of optical chips above 25G is only 5%, and high-end optical chips are still in the hands of U.S. manufacturers such as Coherent and Cisco. Coherent, through Finisar, has been the leading manufacturer of these transceivers for the past 22 years.
Driving Forces for Coherent in Artificial Intelligence
The growing demand for 800G datacom transceivers is fueled by advancements in AI networking, Ethernet, and InfiniBand
AI Networking enables communication and data exchange in AI and ML (machine learning) systems, and is designed to handle large data volumes and high-speed connections.
Ethernet is a widely-used networking technology enabling device communication within a local area network (LAN).
InfiniBand is a high-performance networking technology, primarily utilized in supercomputing and data centers, and is ideal for handling large data transfers in AI and ML environments.
As data centers expand to handle AI and ML workloads, the need for faster, more reliable connections becomes crucial, and the speed of transceivers is critical to the performance of the network. Coherent’s transceivers are protocol-agnostic, meaning the same transceiver hardware can support Ethernet and InfiniBand, as well as proprietary protocols for AI and ML such as Nvidia’s NVLink.
As noted in its earnings call, Coherent saw strong sequential growth in its 800G datacom transceiver revenue in Q4 and are also seeing increasing orders in backlog for the current and future quarters. The company also delivered initial samples of its 1.6T datacom transceivers, which are expected to begin ramping in calendar 2025.
Datacom Transceiver Market Size
Chart 1 shows the market for datacom transceivers by speed between 2023 and 2028. As shown, 100G, 200G, and 400G are experiencing a gradual decline or stabilization as demand shifts towards higher-speed transceivers.
800G transceivers are experiencing rapid growth and are becoming a key segment in the mid-term.
1.6T will begin to gain traction and exhibit significant growth starting around 2026.
3.2T transceivers will emerge by 2026 and experiences rapid expansion through 2028.
Chart 1
As Coherent noted in its recent 10K and noted above:
“Today, more than 50% of Coherent’s datacom revenue is generated by 200G and higher data-rate transceivers. Driven by the demands of growing AI/ML adoption, 800G transceivers are shipping in production and we expect the first 1.6T transceiver samples will be shipped later this calendar year. In five years, the market opportunity for 800G and 1.6T datacom transceivers is expected to be greater than all other types of datacom transceivers combined, largely driven by AI and ML.”
Coherent’s verbiage is consistent with our analysis, and illustrates the demand and growth of its products.
However, Coherent faces strong competition in the 800G market. Chart 2 shows my analysis of the market share for 2023.
Chart 2
Cisco (CSCO) was the market leader in 2023 with a 30% share, followed by Arista Networks (ANET). Coherent’s share is in the “Others” category.
Investor Takeaway
Coherent’s new CEO Jim Anderson commented in the earnings call
“We're breaking down the company and each one of its individual product line divisions. And then we're grading each one of those on a set of strategic and financial criteria. And then what we're doing is putting each one of the businesses into one of four categories….And then the nonstrategic and underperforming businesses are really businesses that just don't fit with the overall portfolio or significantly underperforming our financial targets.”
That will help with massive debt. According to Richard Martucci - Interim CFO who commented in the earnings call:
“We paid down $64 million in debt during the quarter and a total of $229 million for all of fiscal 2024. Total debt at the end of FY '24 is $4.17 billion.”
Growth for the company has the potential to be strong. As shown in Chart 3, the TAM (total available market) in datacom transceiver is forecast to double, from $5.1 billion in 2023 to $11.4 billion in 2028
Chart 3
Nvidia announces its earnings on Wednesday August 28. Growth in its AI datacenter sector will be a catalyst for growth in Coherent’s 800G transceivers.
I continue to rate the company a BUY.