LightTrends

 

Why Acacia is Looking for an Exit?

 

LightCounting Comments on Acquisition of Acacia by Cisco

 

Cisco announced today that it has reached an agreement to acquire Acacia for $2.6 billion, which is a very respectable value for a company of 400 people and implies a more than 40% premium to Acacia’s previous stock price. Yet, it is only about half of the company’s peak valuation, which was reached in 2016 soon after the company completed its IPO. Some of this discrepancy is clearly because of the price run-up due to post-IPO excitement, but more recently the changing market situation has also made an impact.

The trade war between the US and China limited the growth of Acacia’a business in 2017-2018. The ZTE ban in April 2018 and Huawei ban in May 2019 had direct negative impacts on the company valuation. ZTE remains Acacia’a largest customer and it is very likely that FiberHome is using Acacia’s products as well. The long term risk associated with doing business in China is a significant problem for the company.

Apart from direct restrictions on sales to China, the risk includes changes in strategies of Chinese equipment vendors. ZTE and FiberHome are clearly following the example of Huawei in developing internal manufacturing of semiconductor ICs, optical components and modules to ensure a secure supply of these products. The Chinese government is also prioritizing domestic manufacturing of IC and optical chips, including coherent DSPs, and investing heavily in start-ups, such as Wingcomm ��� profiled in LightCounting’s research note on OptiNet China.

Another trend limiting Acacia’s market is the continuing dominance of large companies in the global market for optical transport equipment.�� Figure 1 shows market shares of the leading suppliers in this market, calculated in terms of number of coherent DWDM ports shipped in 2018. All the leading suppliers have internal manufacturing capabilities for DSP chips and even transponders. The “All other” category includes equipment vendors that rely on merchant market coherent DSPs and coherent transponders.

This data suggests that the merchant market accounts for just 15% of the total number of coherent DSPs deployed. If merchant suppliers had access to the whole market, their business opportunity would increase by about a factor of almost 7, which is very unlikely given the continuing dominance of the larger vendors. Cisco was the only vendor with internal DSP manufacturing that started using the latest Acacia DSP chips in its products. Infinera started using Acacia’s product after acquiring Coriant in 2018, but their long term strategy is focused on internal sourcing of all optical and DSP chips.
In an effort to limit the scale of merchant DSP suppliers, Ciena, Huawei and Infinera also plan to start making and selling pluggable DWDM transceivers, competing with Acacia and other module vendors.

Figure 1: Market shares of the leading DWDM transport equipment suppliers

Source: LightCounting report titled “Emerging Market for PAM4 and Coherent DSPs” February 2019

Scaling up the volume of DSP chip sales is critical. Development of these complex ASICs costs tens of millions of dollars, while manufacturing them in higher quantities is relatively easy. Suppliers who achieve the highest scale will have more resources for the development of next generation products and will gain market share. Acacia may reach larger scale being part of Cisco’s business.

Longer term market opportunities for Acacia’s coherent DSPs and transceivers included shorter reach modules, starting with 120km reach 400ZR and even 10km reach 800G optics. However, there is more uncertainty with the timing for these products, given slower than expected demand for high speed optics from Cloud companies in late 2018 ��� early 2019. LightCounting will comment more on this situation next week in its Mega Datacenter Optics report.

Considering all these risk factors, Acacia’s management made a prudent decision to join forces with Cisco.

LightCounting clients can access full text of the research note at: https://www.lightcounting.com/login.cfm

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