August 07, 2012 - 10:38am EST by
2012 2013
Price: 9.29 EPS $0.67 $0.78
Shares Out. (in M): 9 P/E 13.9x 12.0x
Market Cap (in $M): 84 P/FCF 0.0x 0.0x
Net Debt (in $M): -51 EBIT 6 7
TEV (in $M): 32 TEV/EBIT 5.4x 4.6x

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  • Fiber
  • excess cash
  • Illiquid


Alliance Fiber Optic Products is a very inexpensive call option on the bandwidth needed to keep up with the rapid growth of data in today's telecom network and data center networks.  The stock is at $9.29 and has $5.70 per share in net cash and $7.20 per share in tangible book value.  It is on track to generate $6.0m in EBIT this year and $7.0m in EBIT next year, for TEV / EBIT multiples of 5.4x in 2012 and 4.6x in 2013.  The company operates in two divisions; one makes interconnects that connect fiber optic cables to one another, and the second makes passive optical components that act on incoming light waves to split them or change their direction.  The interconnect business accounts for 65% of revenue while the passives business accounts for the remainder.  Both businesses are driven by the same trends and serve the same end markets. 
Alliance is a well managed company having generated positive EPS since the first quarter of 2007, in both positive and negative markets for fiber optic components.  The company's revenue has grown generally except during the recession in 2009 and during an industry-wide inventory correction last year.  The CEO, Peter Chang, is well incentivized to grow shareholder value as he owns 10% of the company himself.  In recognition of the stock's cheapness, the company launched a $6m stock buyback plan earlier this year. 
The stock is often linked with its fiber optic peers, Finisar, JDS-Uniphase, Oplink, and others.  However AFOP has outperformed these peers on a fundamental basis over the past couple of years.  I think the primary reason for this has been the specific endmarkets that each of these companies addresses.  AFOP's peers primarily focus on the core of the network with their active components such as lasers and tranceivers.  The telcos have been reluctant to spend the money to upgrade the core during these tough economic times and have just run their networks "hotter" meaning at higher utilizations.  Alliance, on the other hand, generally sells to enterprise data centers and telco fiber-to-the-home installations, both of which have been higher spending priorities during that time.
Owning Alliance has been somewhat of a frustrating enterprise to date as the stock has not appreciated proportional to its fundametal performance.  It often rises more on the coattails of the performance of its fiber optic peers than on its own merits.  The stock got as high as $20 two years ago as the industry benefited from a spending blip by its customers but came back down in the ensuing inventory correction last year.  AFOP is a fairly illiquid stock and this is a primary reason why it does not react to its own fundamental good news.
The reason I called AFOP a call option on the industry is its tendancy to appreciate along with its peers.  What differs from a standard call option is that AFOP's stock price is gradually improving with its own success so you are getting paid to wait for the next upturn in the industry.        


There are two potential catalysts for Alliance, one is fundamental and the other is strategic.  At some point there will need to be an upgrade of the telecom core networks as utilization can only go so high with degradation of the performance of the networks.  I think that many telcos skipped the 40G upgrade cycle and chose to wait for 100G equipment to upgrade their networks.  This upgrade should start in late 2012 and continue through 2013.  AFOP is also a good candidate to be acquired.  The company is very cheap and has produced some very innovative products considering its small size.  Oplink might make a good buyer it they has $175m in net cash and some complementary product lines.   
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