3D sensing is going to be huge for Lumentum. It is a reinvention of the company. Lumentum will see their revenues related to Apple go from essentially zero in the first quarter of 2017 to at least $145 million in the last quarter of 2017 based on their guidance. In nine months, Apple will have gone from 0 percent to 40 percent of Lumentum's total revenues. The impact of 3D lasers on Lumentum as a percent of revenues is higher than for any of the other companies mentioned above.
So why has Lumentum's stock dramatically underperformed its 3D sensing peers? Lumentum's historical business of manufacturing optical modules for the telecom industry has been in a horrible decline over the past year. Lumentum's revenue from China has been cut in half from the peak and demand from US telecom carriers has also been weak given all of the merger activity over the past year.
As a result, Lumentum's optical communication revenue was down 22 percent year-over-year in the September quarter helping to drive a nearly 30 percent decline in the stock price from its recent peak. As a result, Lumentum's stock is up only 22 percent this year versus gains of 70 percent to over 300 percent for their 3D sensing peers.
This has created the buying opportunity in Lumentum's stock. We think it is only a matter of time before Lumentum's stock comes roaring back as 3D technology proliferates across the technology landscape in 2018 and the telecom business stabilizes and recovers.
So a company with this type of potential must be expensive, correct? Wrong! Because of the steep declines in their historical optical business, Lumentum trades only at a price-to-earnings (PE) ratio of 12 times. The stock seems extremely cheap compared to the other companies in the 3D sensing space. Closely related companies, Win Semiconductor which manufactures the lasers for Lumentum trades at 23 times 2018 earnings and IQE which supplies the epitaxial wafers on which these lasers are manufactured trades at 38 times.
We believe in 2018, Apple will also expand this technology to iPads which sell over 40 million units each year. The Chinese smartphone vendors will also introduce their own 3D sensing enabled smartphones in 2018. Lumentum already has orders in hand 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 think overall Lumentum revenues could be up even more than current expectations for 29 percent revenue growth in 2018 and 64 percent earnings growth.
We think there is an even bigger disparity in 2019 between current expectations and reality. Wall Street expects Lumentum's revenue growth to slow to 5 percent in 2019 and earnings growth to slow to 11 percent. But by 2019, the Android smartphone vendors which are over 80 percent of the units in the global market will start to catch up with Apple in adding 3D sensing features to the phone. Also Apple will have added a world facing 3D camera by this point doubling the number of lasers per phone.
In conclusion, as we eagerly await Luke Skywalker powering up his light saber once again, remember that lasers are not just for Jedis anymore and the technology will be coming to a phone near you. May Lumentum be with you.
Commentary by Dan Niles, founding partner of AlphaOne Capital Partners and senior portfolio manager of the AlphaOne Satori Fund. Previously, he was a managing director at Neuberger Berman, a subsidiary of Lehman Brothers.
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