NeoPhotonics expands vertical integration strategy through semiconductor acquisition

OVUM VIEW

Summary

NeoPhotonics on January 22 announced a definitive agreement to acquire the semiconductor optical business unit of Lapis Semiconductor Co., Ltd, formerly Oki Semiconductor. The acquisition adds high-speed analog semiconductor and optoelectronic optical components product design and material processing to NeoPhotonics’ arsenal. Moreover, it expands NeoPhotonics’ vertical integration strategy, improves its position as a leading active components supplier, and increases its addressable market.

Ovum believes the acquisition increases NeoPhotonics’ gross margin and revenue opportunity, but some negative factors will moderate growth. Vertical integration improves gross margins, but we believe NeoPhotonics’ research and development expenditures will remain high, keeping down operating margins. While the acquisition will add to revenues, there will be some fallout as several Lapis customers are NeoPhotonics’ competitors; these customers will likely seek new suppliers. Bottom line: We see a positive outlook for NeoPhotonics resulting from this acquisition, including higher top- and bottom-line results, notwithstanding the challenges.

NeoPhotonics to attack high-speed transmission with vertically integrated products

On January 22, NeoPhotonics announced an agreement to acquire the optical components business unit (OCU) of Lapis Semiconductor for $36.8m in cash. This acquisition expands NeoPhotonics’ vertical integration strategy, bringing gallium arsenide material processing (new to NeoPhotonics) and a team with expertise in high-speed laser driver and transimpedance amplifier product design and manufacturing. Adding analog semiconductor capability is particularly valuable because it provides NeoPhotonics with critical technology for transmission products at 100G and beyond. Once the transaction closes, NeoPhotonics will have captive optical and electrical design and manufacturing control at a level that should allow it to control cost, performance, and time to market, factors that can help deliver winning results when well managed.

OCU is a strong asset addition to NeoPhotonics. It has a long history of successfully designing, processing, developing, and manufacturing high-speed optoelectronic products including lasers, modulators, and photodiodes. Ovum believes its 10Gbps laser driver had market-leading performance for many years. OCU was one of the first to introduce a very-short-reach 40Gbps transmit optical subassembly, for which it developed an externally modulated laser and driver. It now produces 100Gbps optoelectronic components for both client- and line-side transmission.

The acquisition provides NeoPhotonics with a toolkit to deliver vertically integrated products and positions the company to attack the high-speed transmission market. Ovum believes the strength of this acquisition can be realized if NeoPhotonics brings differentiated 100G transmission products to market within a reasonable cost and time. The technical problems are challenging and the competitive space formidable. NeoPhotonics will be directly competing at the high end with companies such as Finisar, JDSU, and Oclaro for both 100G client- and line-side transceiver revenues.

But don’t expect simple additive revenue growth

Ovum does not believe that the revenue performance of NeoPhotonics plus OCU will simply be additive. NeoPhotonics reported that OCU posted revenues of $45m for the past nine months, of which 6% was from NeoPhotonics and 30% was attributable to sales to network equipment manufacturers, suggesting that over 60% of revenues came from NeoPhotonics competitors. We believe OCU has differentiated technology that will be very difficult to duplicate with other suppliers. We also acknowledge it is common for suppliers to purchase products from competitors in optical components. But even with the best intentions of NeoPhotonics to continue serving OCU’s current customer base and the challenge of finding a second source for the unique OCU products, some OCU customers will find a new supply source. Since finding a new source may take time, the revenue impact is likely to be minimal in 2013.

New revenue opportunity for NeoPhotonics

NeoPhotonics’ 100G transceiver product listing on its website at the time of this writing is only a 10×10 MSA-compliant device that supports 10km. This suggests NeoPhotonics does not have an existing 100G coherent transceiver. It also suggests it does not have a 100G IEEE-compliant transceiver. Ovum’s forecast identified 100G transceivers as the fastest-growing segment; sales of transceivers for single mode are estimated to reach over $2bn by 2017, with a compound annual growth rate of over 50% from 2012–17 (see 40G and 100G OC Forecast Spreadsheet: 2012–17, TE003-000519, August 2012). The acquisition puts NeoPhotonics in position to compete for this revenue. We don’t expect revenues from this new area to start flowing right away, but these products should start to ramp as the OCU revenues decline.

Expect high research and development expenditures to persist

We also expect high research and development expenditures to continue for NeoPhotonics. We believe the company will continue spending 15–17% of revenues on R&D to remain competitive. Finisar and Oclaro are posting R&D expenditures in this range, which is higher than that of other optical component suppliers who publicly report financials. Suppliers who solely support either passive or active components typically spend 8% of revenues on R&D, while companies with cutting-edge technologies that are both active- and passives-based require twice that amount. We expect NeoPhotonics’ gross margin to improve, but operating margins will continue to be challenged with the higher R&D spending.

APPENDIX

Author

Daryl Inniss, Practice Leader, Components

daryl.inniss@ovum.com

Further reading

“NeoPhotonics acquires Santur: Photonics integration moving to center stage,” TE003-000353 (September 2011)

“NeoPhotonics’ high-valued, strings-attached investment looks like a win,” TE003-000465 (May 2012)

OC Forecast Report: 2012–17, TE003-000521 (August 2012)

40G and 100G OC Forecast Spreadsheet: 2012–17, TE003-000519 (August 2012)

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