Despite all the recent tumult in Tech equities recently, optical networking stocks such as Fabrinet and Coherent are quietly nearing or breaking their highs as earnings confirm that a new spending cycle on optical gear from data centers is on track.
Last night, Fabrinet reported Q4 revenue growth of 15%, 3% above expectations. If these figures are not as flashy as those delivered by Nvidia and AI chip peers, it’s worth noting that they hide two different realities. While telecom revenue are a drag (-20% for the year) due to continued inventory digestion across the telecom industry, the Datacom business is indeed booming (+63% growth in Q4, +120% over the year).
Going forward, we believe the sector’s growth profile should gradually improve (to 20-30% growth) as the business gradually skews towards data centers (c.50% of total revenue at Fabrinet in Q4), as growth appears sustainable in this data center segment and as telecoms start to recover.
Indeed, cloud giants have raised again their data center capex in their latest quarterly reports and all optical gear suppliers have commented about strong demand trends, with no impact from the slight push-out of the latest Nvidia GPU (Blackwell).
As we said previously, data center spending strength is now broadening well beyond GPUs and is lifting demand for networking equipment. Moving bits around in data centers is probably one of the largest limiting factors to fully exploit today’s available computing power. Optical transmissions allow to reduce latency and, more importantly, significantly reduce the necessary energy for data transfers, which represent about 25% of data centers’ total electric power consumption.
As the speed of networks is relentlessly increasing (we are currently in the 800Gbps rollout phase), the complexity of one of the key processes, the opto-electronic conversion, is shooting through the roof with regard to the techniques of signal processing (DSP and retimer) and the management of lasers.
Turning to the telecom segment, Fabrinet’s commentary about a stabilization of the business is consistent with the messages provided by many other networking specialists recently including Cisco, Ciena or Infinera. Considering that expectations for this business are low, any material recovery of the telecom segment would contribute to the accelerating growth dynamics of Fabrinet and peers and to earnings upside.
In conclusion, the optical and networking space remains highly attractive in our view as it combines strong exposure to data centers, an accelerating growth outlook and still reasonable valuations (on average around 20x forward EPS), leaving significant room for a continued rerating.
