Flood in Thailand Will Reshape the Landscape of the Global Optical Components Industry

The latest flood in Thailand is redefining the meaning of the “world is flat” theory proposed by Thomas Friedman a few years ago. The optical communications industry took notice as flood waters broke the defenses around the 300,000-square-foot Fabrinet manufacturing plant in Chokchai (near Bangkok) on October 22 and rose 5 feet above the floor level of this largely ground-floor-based facility that houses almost half of Fabrinet’s manufacturing. The flooded factory is likely to be abandoned as Fabrinet plans to transfer production to a newer facility a few miles away (and more importantly, 5 feet higher in elevation), but consequences will be farther reaching than that. The optical communications market will continue to grow despite interruptions of supply for a few sole-source products made at Fabrinet, such as tunable transceivers and WSS modules, but the industry landscape will change significantly.

Fabrinet, a contract manufacturer based in Thailand, emerged as one of the most reliable partners for optical component manufacturers over the last decade. Fabrinet’s factory-within-a-factory business model was designed to enhance protection of intellectual property while offering opportunities to reduce production cost and minimize logistical burden, because clients were offered exclusive engineering teams and production space within a large facility. By 2010, Fabrinet revenues exceeded $400 million, and the company completed its IPO. For the fiscal year ended June 24 2011, the company reported almost $750 million in revenues with close to $600 million coming from the optical communications market. Its largest customers include Emcore, Finisar, JDSU, Oclaro, and Opnext, which collectively accounted for close to 60% of Fabrinet revenue in the last fiscal year.

Although larger and diversified vendors like Finisar should not have problems navigating through disruptions caused by the flood, smaller companies relying heavily on Fabrinet for manufacturing will be truly struggling. Even midsize companies, like Oclaro and Opnext are expecting significant declines in Q4 2011 revenues. In the case of Opnext, 43% of its revenue came from products made at Fabrinet. Many smaller vendors with even higher exposure to Fabrinet or other companies based in Thailand and affected by the flood may not be able to recover.

The flood is also likely to be followed by a wave of M&A activity in the industry, as smaller and even midsize businesses will be forced to put all options on the table. No matter how difficult this will be, the optical component and module manufacturing could use some consolidation. The “State of the Optical Communications Industry” report, published by LightCounting in July 2011, included data on market shares of the top three optical transceiver suppliers, which reached 45% by 2008 but have not changed significantly since then. Also, majority of the suppliers lack diversification, as they tend to focus on a single market or technology. This will have to change as the industry matures, and the flood may accelerate this process.

Among the products most affected by the flood are tunable XFP transceivers and WSS modules made at Fabrinet for Emcore and JDSU, 10 Gbps transceivers made for Finisar and Opnext, and amplifiers and optical modulators made for Oclaro. Supply of WSS modules will be disrupted significantly, because these products are often sourced from a single supplier. However, demand for WSS modules fell sharply in the last two quarters, so it is very likely that JDSU will have an extra inventory to mitigate the disruptions. Demand for tunable XFP modules was very strong last year but softened in the middle of 2011, suggesting that there may be some excess inventory as well. Since Emcore and JDSU accounted for close to 100% of the tunable XFP market, it will be up to Finisar and Oclaro, who introduced this product more recently, to fill in the demand. Other products affected by the flood should be available from a number of other suppliers, so customers will be able to find alternatives. We do not expect a significant impact of the flood on the total sales of optical components and modules in Q4 2011, as sales of WSS and tunable XFP modules account for less than 10% of the total market.

One of the main reasons for Fabrinet’s success over the years is its excellent management team and dedicated staff, who all are working hard now on resuming production. Fabrinet is completing a new 320,000-square-foot facility at its Pinehurst Campus, which will be able to house former Chokchai operations. The company is also planning to diversify manufacturing to a facility in the northern part of Thailand, or even a different country, to mitigate the risks of natural disasters.

Production at Pinehurst Campus (which was not flooded) resumed on November 7, and the company is sheltering 700 of its employees at its facilities and providing them with food and basic services. Shipping infrastructure in Thailand is also starting to function. However, there is still a lot of water coming from the north, and Fabrinet management warned that events may change hourly. We will all hope for the best.