Why Acacia Communications, Inc. Stock Tanked Today

ZTE was ACIA's biggest customer, implying troubled times ahead for ACIA stock

ACIA stock - Why Acacia Communications, Inc. Stock Tanked Today

Source: Shutterstock

The trade war is starting to rear its ugly head.

Shares of optical equipment provider Acacia Communications, Inc. (NASDAQ:ACIA) are dropping big on news that the U.S. Commerce Department is banning companies from selling to Chinese phone-maker ZTE Corp. ACIA stock is down more than 30% as of this writing.

Why? ACIA sells a ton of stuff to ZTE. Thus, losing the ZTE business leaves a huge hole in the company’s financials.

More broadly, ACIA does a lot of business in China. Thus, if trade war talk translates into more action, ACIA stock could fall even further.

Is there a bounce-back in the cards for ACIA stock? Not yet. The company’s lost revenues and profits from the ZTE ban don’t seem fully priced in at $27 per share. Moreover, because of the massive China exposure, ACIA could lose more than just the ZTE business.

All together, ACIA stock is down big today for a good reason. The dip may look compelling, but it isn’t an opportunity just yet.

Why ACIA Stock Is Down So Much

For those who follow optical equipment provider ACIA, you are well aware that one of the biggest knocks against this company is that it lacks customer diversity. Indeed, in the company’s most recent 10-K filing, the company says that they have “historically generated most of our revenue from a limited number of customers”.

How much is “most”? Over the past 3 years, ACIA’s top 5 customers have accounted for 70-80% of the company’s total revenues.

Thus, losing any one of the those top 5 customers is a big deal to ACIA.

But ZTE isn’t just any one of the top 5 customers. ZTE is the biggest customer by a long shot. Over the past 3 years, ZTE has accounted for roughly 30% of ACIA’s total revenues.

More than that, ACIA has a ton of China exposure. China accounted for roughly 40% of ACIA’s total revenues over the past 2 years, and last year, the China business was more than double the size of the U.S. business. Due to trade war fears, that massive China business is at-risk.

Why It Isn’t A Buy Yet

ZTE accounts for 30% of ACIA’s revenues. Thus, a 30% drop in ACIA stock on news that the company is losing ZTE business seems to make sense.

But this 30% drop doesn’t fully account for all the risks associated with the company currently.

Firstly, there is another 10% of revenue that is from China but not from ZTE which at risk to going to zero due to escalating trade war talk. Clearly, that isn’t priced in on this 30% drop.

Secondly, there is no way that ACIA maintains its current operating and net profit margins while losing 30% of its revenues. Gross margins may remain the same, but the company will lose a ton of scale with the ZTE business gone. As that scale disappears, so will a ton of operating leverage.

In other words, there is no way that the company cuts operating expenses by enough to offset a 30% drop in revenue. As such, operating margins will drop, meaning that earnings will drop by much more than 30%.

Because of these two factors, ACIA stock doesn’t seem to be appropriately priced here and now, even after a 30% drop in the stock price.

Bottom Line on ACIA Stock

When ACIA stock went public in 2016, it had a massively successful honeymoon with Wall Street. Buoyed by a bullish sentiment regarding fiber-optic build-out in China, ACIA stock soared from an IPO price of $23 to over $120 in a few months.

But the biggest knock on ACIA over the past several quarters has been the company’s lack of customer diversity. That has worried investors for some time, and now, it is starting to rear its ugly head.

But even after a 30% drop, ACIA stock isn’t a bargain. This stock needs to fall another 10-15% before looking like good value.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/2018/04/why-acacia-communications-inc-stock-tanked-today/.

©2020 InvestorPlace Media, LLC