My top pick for 2017 is optical interconnect company Acacia Communications (ACIA) . I'm a huge believer in the coming optical super cycle and I think Acacia will be a leader.
Back in September, I thought investors should wait for the stock to cool down before buying. The shares were up 270% after the company's May IPO.
The stock took a beating during September and October, but I think the momentum will return as the company launches a slew of new products next year.
Acacia's shares have been hurt by news of another company in the sector. On Oct. 26, long-haul optical maker Infinera (INFN) reported a terrible third quarter, and gave lower guidance for the fourth quarter.
But Infinera has been having problems for a while; its second quarter was a mess too. Investors were hoping for revenue growth by the fourth quarter, but management said the turnaround would take longer and be more expensive than anyone had imagined. Disappointed, investors dumped the entire optical group.
The next day, Acacia was hit by a report that its largest customer, Chinese telecom giant ZTE Kangxon, issued cautious guidance. In the first half of 2016, ZTE accounted for 38% of Acacia's revenue. At the end of the quarter, ZTE accounted for 63% of revenue.
Acacia's optical-interconnect products use special silicon photonic integrated circuits (or "silicon PICs") that the company crams with a billion transistors that convert the light coming off of a fiber-optic cable into usable data. Acacia's silicon PICs also include a whole series of low-power digital signal processors (DSP) and all associated logic.
Acacia packs these silicon PICs into 5-inch-by-7-inch cases that plug right into industry-standard backplanes, and because the company's pics do everything in silicon, they're crazy fast. These babies can chow down on a 100-gigabyte fiber-optic cable's output with ease. In fact, the company has even developed pics that can handle up to 400-gigabyte feeds, and ACIA is already working on a one-terabyte version.
Optical parts have also been extremely difficult to manufacture to date. However, Acacia can make its silicon pics using traditional wafer-fab equipment like the kind made by Applied Materials (AMAT) . And while the optical interconnects of old (i.e., two years ago) needed lots of additional circuitry that took up space and power, Acacia is creating integrated circuits that are essentially powered by light. The ability to make silicon that can process light as easily as electrons is a major engineering achievement.
Earlier this month, the company's management started making the rounds of the investment community to talk about the company and the future of the optical business.
Management believe the company's CFP2-DCO PICs, which contain a digital signal processor on board, are light-years ahead of the competition. The company's highest speed product, the AC400, which can handle 400 GB, has been added to Action Alerts PLUS charity portfolio holding Facebook's (FB) Voyager Data Center Interconnect (DCI) initiative. Voyager is Facebook's attempt to lower the cost of constructing an all-optical data center. Facebook hopes "hyper scale" cloud vendors will adopt its designs. The hyper scale data centers are the fastest-growing part of the optical business.
As the CFP2-DCO, CFP2-ACO and the AC400 ramp into volume production in the first half of 2017, the company should begin to pick up more customers as the year progresses. Management indicated its newer parts have lead times as long as 16 weeks, which gives the company great visibility into earnings. In addition, it is no small task to design these parts into new products, and it can take as long as 18 months for new customers to start ordering parts.
In fiscal 2014, the company reported revenue of $146 million. I think it can report over $650 million in 2017 and $750 million the year after. Likewise, earnings should accelerate from $0.44 in 2014 to $4.20-$4.50 by 2018.
The optical sector is very risky and Acacia is no exception. The company operates on the bleeding edge of technology and there are few customers in the world that can consume these types of parts.
Right now, Chinese telecom ZTE Kangxon accounted for 63% of revenue, which makes the stock very risky. ZTE recently lower its guidance and the news hit ACIA. But I'm confident 2017 will be the year when the company will be able to broaden its customer base.
I don't think the shares will be in the doghouse too long. Tech momentum investors can't resist companies like Acacia and they will back once the company starts reporting blowout numbers again.
I think ACIA can reach $100 per share by summer.
