Year to date, shares of Acacia Communications (ACIA) - Get Report are up 147%, but they would have been higher if not for the shellacking the stock took in the last month. After the company's IPO in May, the stock ran from $27 to as high as $128, only to fall 40% to the low $70s.
Back in September, I was bullish on Acacia, but I suggested investors wait for a pullback.
The stock was hurt by news of another company in the sector. On Oct. 26, long-haul optical maker Infinera (INFA) reported a terrible third quarter, and gave lower guidance for the fourth quarter. But Infinera has been having problems for a while. Infinera's 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. Investors were disappointed and 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.
On Nov. 10, Acacia said third-quarter fiscal 2016 earnings of $1.01 per share were 15 cents better than the consensus estimate. Revenue rose 106.8% to $135.3 million, vs. the consensus estimate of $132.7 million.
Management gave fourth-quarter guidance that caused investors to temper their enthusiasm for the stock. The company said it predicts fourth-quarter revenue of $136 million to $141 million, vs. the $138.9 million consensus. Investors were expecting more than an in-line fourth quarter.
But investors seemed to have forgotten the company beat the original third-quarter numbers substantially. The company preannounced a blowout third quarter and then beat the prereleased numbers again. So the fourth quarter numbers are actually a lot higher than anyone ever expected when Acacia went public in May.
But that didn't matter. Investors quickly came to the conclusion that telecom spending on optical gear had come to a grinding halt. In fact, just the other day, Action Alerts PLUS holding Cisco (CSCO) - Get Report said its service provider business was down 12% in the third quarter.
There are not a lot of customers in the optical space, so when there is a slowdown, it can hit the stocks pretty hard. In the first half of fiscal 2016, five customers accounted for 80% of Acacia's 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 are packed with a series of low-power digital signal processors and 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.
Acacia's PICs 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 it is already working on a one-terabyte version.
While customer concentration is a serious concern, management is working hard to add new customers. In the quarter, Acacia announced it had signed deals with webscale customers (like Facebook (FB) - Get Report and Alphabet's (GOOGL) - Get Report Google) and Chinese equipment maker Huawei.
On Tuesday, the IPO lockup expired, which allowed insiders to sell their shares. There could be a few volatile sessions as insiders take profits.
I think this is a good time to pick up some Acacia stock. The company's products are still in high demand as the optical supercycle is just getting underway.
With the Trump administration talking about tariffs on Chinese products, ZTE could stop purchasing Acacia's products altogether. And its not known if the U.S. Department of Commerce will allow ZTE to continue to purchase Acacia's products past June. These concerns could be risks to my investment thesis going forward.
But, that said, I think shares of Acacia can get back on the rocket ship to $100 per share.
This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.