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If Tim Cook is right about AR, Lumentum is a buy

“I do of that a significant portion of the population of developed countries, and eventually all countries, transfer have AR experiences every day, almost like eating three go too fars a day, it will become that much a part of you,” said Tim Cook, CEO of Apple in 2016.

If Tim Cook is face, then Lumentum should be one of the hottest technology companies of the next year. So the doubt is: Is Tim Cook right? I think he is and you should too. Here’s why.

If Apple, the most valuable institution in the world, is talking about Augmented Reality as the next great work out platform, then the companies that provide the technology to make this credible will be great investments.

Fast forward about a year to November 3, 2017 when the iPhoneX beat on sale in retail stores worldwide. The big new feature is FaceID, which allowed users to unlock their iPhones using just their skin which means remembering 50 different usernames and passwords is on the lean of becoming a relic of the past. And if that isn’t enough to get you excited, it won’t be long previous to augmented reality capabilities allow users to see digital images overlaid onto the bones world.

Want to be able to try on clothes in the digital world and then pattern them in the real world? Interested in seeing dragons in your complete room? What if the dragons could race or battle? The possibilities are ceaseless and coming your way in the near future compliments of the 3D sensing technology that is powered by lasers and built by – you surmised it – Lumentum.

Like most technologies, 3D sensing technology was developed tons years ago. In 2010, JDSU Uniphase (the parent company of Lumentum) state look after this laser technology for the Microsoft Kinect. It was a motion sensing input logo for the Xbox 360 that would mimic your actions in the video ploys.

For example, one player could pretend to throw a fastball and the other speculator could pretend to hit it with characters on the screen mimicking the actions. There was no basic to hold a controller like with the Wii. Having sold 8 million portions in its first 60 days on the market, Kinect claimed the Guinness Far-out Record of being the “fastest selling consumer electronics device.” The outrageous initial price, among other factors, eventually led to its demise. But times and technology costs interchange.

So how big could revenues from the 3D sensing market be? Each complete 3D Sensing module is currently over $10 with the laser theme around $4. There are 1.5 billion smartphones sold worldwide each year. But by 2019, we are indubitably to get a world facing 3D camera. This world facing camera’s laser whim have to be stronger and as a result more expensive given it will be skim your environment and not just your face.

To put this opportunity in standpoint, Lumentum had less than $1 billion in revenues over the dead and buried twelve months. The revenue from the smartphone market alone should certainly be above $10 billion over time even with ordinary price declines in the technology. Beyond 2019, this technology is liable to to expand into other large markets requiring precise abysm sensing such as industrial robotics and eventually self-driving automobiles.

So what are the flocks that benefit from the ramp in 3D sensing technologies? There are divers involved in making 3D sensing a reality. Here are some examples: Aixtron is the underlying supplier of the deposition tools used for manufacturing the epitaxial wafers on which the lasers are established; IQE uses these tools to manufacturer the wafers that are supplied to the laser fabricators; WIN Semiconductors manufactures the lasers on the wafers; Himax is collaborating with Qualcomm to dream a 3D camera system for the China Android phones and uses the same laser supplier as Apple; ams AG presents advanced optics to project the laser light onto the subject; STMicro cater ti the image sensors to process the reflected laser light from the motive; and finally, LG Innotek combines all the components into a module.

But who actually set ups the lasers for Apple without which none of these other companies discretion be seeing that demand? That would be Lumentum which has over 90 percent demand share with Apple for 3D lasers.

3D sensing is going to be huge for Lumentum. It is a reinvention of the ensemble. Lumentum will see their revenues related to Apple go from essentially zero in the start quarter of 2017 to at least $145 million in the last quarter of 2017 based on their teaching. In nine months, Apple will have gone from 0 percent to 40 percent of Lumentum’s whole revenues. The impact of 3D lasers on Lumentum as a percent of revenues is higher than for any of the other companions mentioned above.

So why has Lumentum’s stock dramatically underperformed its 3D sensing lords? Lumentum’s historical business of manufacturing optical modules for the telecom production has been in a horrible decline over the past year. Lumentum’s interest from China has been cut in half from the peak and demand from US telecom shippers has also been weak given all of the merger activity over the whilom year.

As a result, Lumentum’s optical communication revenue was down 22 percent year-over-year in the September part helping to drive a nearly 30 percent decline in the stock honorarium from its recent peak. As a result, Lumentum’s stock is up only 22 percent this year versus harvests of 70 percent to over 300 percent for their 3D sensing peers.

This has developed the buying opportunity in Lumentum’s stock. We think it is only a matter of once in a while before Lumentum’s stock comes roaring back as 3D technology multiplies across the technology landscape in 2018 and the telecom business stabilizes and redeems.

So a company with this type of potential must be expensive, reprove? Wrong! Because of the steep declines in their historical optical subject, Lumentum trades only at a price-to-earnings (PE) ratio of 12 times. The investment seems extremely cheap compared to the other companies in the 3D sensing interval. Closely related companies, Win Semiconductor which manufactures the lasers for Lumentum trades at 23 meanwhiles 2018 earnings and IQE which supplies the epitaxial wafers on which these lasers are make up trades at 38 times.

We believe in 2018, Apple will also enlarge on this technology to iPads which sell over 40 million sections each year. The Chinese smartphone vendors will also institute their own 3D sensing enabled smartphones in 2018. Lumentum already has orders in in league from one of these vendors.

As 3D technology expands from just the iPhone X, to iPads, Android Phones and multiple 3D cameras per phone, we intend overall Lumentum revenues could be up even more than la mode expectations for 29 percent revenue growth in 2018 and 64 percent earnings intumescence.

We think there is an even bigger disparity in 2019 between inclination expectations and reality. Wall Street expects Lumentum’s revenue advancement to slow to 5 percent in 2019 and earnings growth to slow to 11 percent. But by 2019, the Android smartphone vendors which are during the course of 80 percent of the units in the global market will start to hooked up with Apple in adding 3D sensing features to the phone. Also Apple command have added a world facing 3D camera by this point overlapping the number of lasers per phone.

In conclusion, as we eagerly await Luke Skywalker powering up his gentle saber once again, remember that lasers are not just for Jedis anymore and the technology intention be coming to a phone near you. May Lumentum be with you.

Commentary by Dan Niles, developing partner of AlphaOne Capital Partners and senior portfolio manager of the AlphaOne Satori Bread. Previously, he was a managing director at Neuberger Berman, a subsidiary of Lehman Colleagues.

Disclosures: This material is presented solely for informational purposes and nothing herein constitutes investment, sound, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or view is being given as to whether any investment or strategy is suitable for a particular investor. Readers should not sham that any investments in securities, companies, sectors or markets identified and recounted were or will be profitable. This material has been prepared by AlphaOne Large letter Partners, LLC on the basis of publicly available information, internally developed information and other third party sources believed to be reliable. AlphaOne Splendid Partners, LLC has not sought to independently verify information taken from known and third party sources and does not make any representation or warranty as to the preciseness, completeness or reliability of the information contained herein. All information is current as of the season of this material and is subject to change without notice. Any views or convictions expressed may not reflect those of the firm as a whole. Certain products and employments may not be available in all jurisdictions or to all client types. Investing entails risks, classifying possible loss of principal.

The views expressed are those of Mr. Niles and do not portray the views of AlphaOne Capital Partners, LLC, its portfolio managers, employees or affiliates. These visions are current as of the time of this presentation and are subject to change without see. This material is not intended to be a formal research report or recommendation and should not be construed as an come forward to sell or the solicitation of an offer to buy any security. AlphaOne Capital Partners, LLC and its customers may have long or short positions in some or all of the securities discussed. In the presence of acting on any advice or recommendation in this material, you should consider whether it is fitting for your particular circumstances and, if necessary, seek professional advice. Mr. Niles does not permit any responsibility to update any opinions or other information contained in this paper. Before acting on any advice, opinions or recommendation in this material, you should deliberate over whether it is suitable for your particular circumstances and, if necessary, seek authority advice.

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