Utilized Optoelectronics: 2024 Ought to Be Robust However Downgrading On Valuation (NASDAQ:AAOI)

Word:

I’ve coated Utilized Optoelectronics, Inc. (NASDAQ:AAOI) beforehand, so buyers ought to view this as an replace to my earlier articles on the corporate.

A bit over two months in the past, I urged buyers to purchase shares of fiber-optic networking merchandise supplier Utilized Optoelectronics, Inc. or “AOI” following a 40% retreat from its 52-week-high of $16.26 marked on August 24.

Whereas shares are up by near 50% since that point, buying and selling within the inventory has been extremely unstable. What at first gave the impression to be a well-timed name began to show into a serious nightmare over the month of October and I finally ended up being stopped out of a sizeable place at a serious loss.

Nonetheless, after briefly dipping beneath $7 in late October, shares have regained their footing and rallied by roughly 100% this month to date, doubtless as a results of renewed power in main AI participant and key buyer Microsoft Company (MSFT).

Earlier this month, AOI reported third quarter outcomes and supplied fourth quarter steerage largely in step with expectations:

That mentioned, free money movement was detrimental – a whopping $18.6 million nearly solely because of a greater than 40% sequential improve in accounts receivable because of large development within the firm’s Datacenter section:

In Q3, Datacenter revenues contributed nearly 80% of whole gross sales. Throughout the Datacenter section, each the corporate’s 100G and 400G merchandise skilled robust development with the older 100G expertise surprisingly nonetheless contributing the lion’s share, as outlined by administration on the convention name:

Within the third quarter, 74% of our information heart income was from our 100G merchandise, 13% was from our 200G and 400G transceiver merchandise, and seven% was from our 40G transceiver merchandise. Notably, income for our 100G merchandise elevated 75% sequentially, whereas income for our 400G merchandise elevated 74% sequentially and accounted for slightly below 11% of our whole information heart income in Q3.

To compensate for the fabric money outflows, AOI continued to promote shares into the open market below its lately expanded Fairness Distribution Settlement with Raymond James (RJF):

Whereas the continuing open market gross sales are diluting current shareholders, I might truly prefer to see the corporate profiting from the newest rally and lift as a lot money as attainable to be able to put together for an upcoming $80.5 million convertible debt maturity on March 15.

Nonetheless, even full utilization of the remaining $26.8 million obtainable below the present Fairness Distribution Settlement gained’t be enough to repay the convertible notes however the firm has enough approved shares to permit for additional upsizing of the settlement.

As well as, a $19.0 million revolving credit score facility with a Chinese language financial institution is scheduled to mature on Could 24.

Please be aware that the corporate determined to terminate the proposed $150 million sale of its Chinese language manufacturing services to Yuhan Optoelectronic Know-how (Shanghai) Co. or “Yuhan” after the customer’s alleged failure to satisfy agreed-upon deadlines resulted in AOI shedding confidence in Yuhan’s potential to finish the transaction, based on statements made by administration on the convention name.

Presently, the corporate is exploring further choices with new potential consumers whereas concurrently pursuing a $3 million breakup price from Yuhan.

For the fourth quarter, the corporate expects 400G product contribution to extend, partially because of earlier-than-expected product shipments below the recently-announced provide agreements with core buyer Microsoft Company (MSFT) for subsequent era lasers and lively optical cables:

As a reminder, as we now have mentioned on our prior couple of earnings calls, we signed two agreements with Microsoft earlier this 12 months, together with a improvement program to make next-generation lasers for its information heart, each for 400G and past, and for the event of their 400G and next-generation lively optical cables. Whereas not assured, we proceed to imagine that the income alternative for our 400G and 800G merchandise may very well be better and an extended length than the income contribution we noticed from this buyer through the peak of the 40G product cycle, which means that income from these merchandise could exceed $300 million over the a number of years of those build-outs.

Throughout the quarter, we obtained requests from Microsoft to expedite our manufacturing ramp for these merchandise, which we are trying to accommodate. Based mostly on these expedite requests, we imagine demand for these merchandise stays robust, and our manufacturing groups are working very exhausting so as to add capability for this manufacturing, which we now anticipate will enable us to start shipments later this month, moderately than in late December as initially deliberate.

With revenues below the brand new provide agreements with Microsoft prone to ramp over the course of 2024 and industrial shipments of the corporate’s new 800G merchandise additionally anticipated for subsequent 12 months, 2024 is prone to be an enormous 12 months for Utilized Optoelectronics.

Nonetheless, these expectations are already very a lot mirrored in present consensus estimates which name for an nearly 60% year-over-year income improve and substantial profitability subsequent 12 months:

Bear in mind, my unique funding thesis was based mostly on much more aggressive development and profitability assumptions in addition to the convertible bonds being transformed to fairness at a conversion worth of $17.55 per share in March.

Whereas nonetheless a definite risk, I’ve determined to take a extra conservative stance and now anticipate the convertible notes to be repaid with money raised from ongoing open market gross sales. As well as, I might assume the projected gross sales development to require further working capital.

Relying on the common gross sales worth, I wouldn’t be shocked to see excellent shares growing by greater than 25% to roughly 45 million by the top of Q1/2024.

Please be aware additionally that the corporate’s in-line quarter and steerage was beneath my beat-and-raise expectations. As well as, I used to be shocked by the income combine nonetheless being heavily-weighted in direction of legacy 100G expertise which is probably going to offer a headwind going ahead.

Because of this, I’m now projecting 2024 revenues of roughly $400 million and earnings per share (“eps”) of $0.75 which continues to be above the high-end of present consensus expectations however considerably beneath my earlier forecast for earnings doubtlessly approaching $1.50 per share subsequent 12 months.

Even when making use of a P/E ratio extra in step with business friends of 20x my 2024 eps forecast, the ensuing worth goal of $15 solely offers for marginal upside from present share worth ranges.

Backside Line

With main AI participant and key buyer Microsoft’s inventory having rallied to new all-time highs in current weeks, Utilized Optoelectronics Inc.’s shares are pink scorching once more.

Whereas I nonetheless anticipate 2024 to be a 12 months of robust development and significant profitability for AOI, the corporate’s Q3 outcomes and This fall steerage got here in beneath my aggressive expectations.

Together with some anticipated headwinds from lowering 100G product income going ahead and assumptions for the corporate repaying the March convertible be aware maturity with money raised from ongoing open market gross sales, I’ve determined to revise my aggressive projections for subsequent 12 months.

Consequently, I’m downgrading the corporate’s shares from “Robust Purchase” to “Maintain” whereas lowering my worth goal from $22.50 to $15.00.