Will Coherent (COHR US) Miss This Time?

As the top one and two players in AI optical communication modules, Innolight, listed on the China A-share market, and Coherent (formerly Finisar), listed on the US market, have always been key companies of interest to tech investors. Recently, with the upcoming of COHR FY3Q24 earnings, there has been a lot of noise in the market regarding the company. Today, I would like to explain about Coherent and its most closely watched optical communication module business by investors.

The recent market noise mainly stems from Innolight, which is listed on the China A-share market, after reporting its 1Q24 earnings last month, mentioned several negative points during its investor roadshows: 1) The company saw its major customer, NVIDIA, revised down its purchase volume for 800G multimode optical modules this year, so the market is concerned that COHR, as NVIDIA's major supplier of multimode modules, will likely miss expectations; 2) The company noticed that due to quality issues with the 800G single-mode optical modules supplied by COHR, NVIDIA increased its orders for single-mode modules from Innolight (i.e., NVIDIA switched its single-mode procurement from COHR to Innolight); 3) The company mentioned that the price of 800G optical modules supplied to NVIDIA will decrease every quarter this year, putting pressure on both Innolight and Coherent. I will explain each of these points below.

1)Innolight saw its major customer, NVIDIA, revised down its purchase volume for 800G multimode optical modules this year?

It is true that NVIDIA did revise down its purchase volume for 800G multimode optical modules from Innolight, but this was entirely due to issues within Innolight itself, and does not imply that NVIDIA reduced its overall purchase volume for 800G multimode modules this year. According to my supply chain research, the 800G multimode optical modules from Innolight have always used Broadcom's photo diode (PD), but unfortunately, the PDs supplied by Broadcom in conjunction with the 800G VCSEL encountered quality issue, rendering the large quantity of Broadcom PDs previously purchased by Innolight unusable. As a result, NVIDIA reduced its purchase volume for Innolight 's 800G multimode optical modules. Innolight currently has to purchase PDs from COHR to match with Broadcom's 800G VCSEL and resend samples to NVIDIA. However, since the transmitting (laser diode) and the receiving end (photo diode) have products from different suppliers, this re-testing and certification process will take some time. As such, NVIDIA has not only not reduced but even increased its purchase volume for COHR's 800G multimode optical modules.

2) Due to quality issues with the 800G single-mode optical modules supplied by COHR, NVIDIA switched its orders from COHR to Innolight?

This is indeed true: In fact, starting from December last year, NVIDIA discovered that when used in client applications, the 800G single-mode optical modules purchased from COHR experienced link-down issues, meaning the optical module would lose connection and require manual reinsertion to restore full functionality. NVIDIA then halted the shipment of these COHR modules from December last year. However, it was later found that this disconnection phenomenon only occurred on NVIDIA's newly upgraded switches, while COHR's optical modules worked fine with NVIDIA's old switches, and the same optical modules worked fine with Google's own switches as well. Subsequently, in late March, COHR re-sent a batch of modified DR8 optical modules to NVIDIA, which have been certified. Coherent’s current schedule is to resume production in early May and resume shipments in late May. Therefore, accurately speaking, from December last year until May this year, NVIDIA suspended the supply of COHR's 800G single-mode optical modules, but COHR will resume shipments from June this year. According to my supply chain research, COHR shipped over 30,000 800G single-mode modules to NVIDIA in 4Q23, with zero shipments in 1Q24. Shipments are expected to resume in 2Q24 at a level of around 30,000 units (mainly in June), and in 3Q24, shipments are expected to increase to 100,000 units, with a chance to ramp up shipments to 200,000 units in 4Q23.

3)Innolight mentioned that the price of 800G optical modules supplied to NVIDIA will decrease every quarter this year, and there is significant pressure to reduce prices going forward?

I believe the situation is true. The price of NVIDIA's 800G multimode modules dropped from over $600 in 4Q last year to slightly more than $500 in 1Q this year, but this is mainly due to the price drop after the new product was mass-produced. Each generation of new products experiences a significant price drop after transitioning from small-scale to large-scale production. Another round of nearly 10% price drop is expected in 2Q24, but the price drop in 2H24 will converge to around 5%. My supply chain check shows that optical module manufacturers in the industry are also trying to reduce the cost of key components, such as replacing the widely used MRVL's 800G DSP with secondary suppliers MXL and AVGO. The current selling price of MRVL's 800G DSP is still around $90, while the mass production price of MXL and AVGO's 800G DSP is only around $50, almost half the price of MRVL's, which will greatly help optical module manufacturers to reduce costs and maintain gross profit margin level.

Currently, the market's consensus expectation for COHR CY1Q24/FY3Q24 800G optical module revenue is between $150-$200 million, and the expectation for CY2Q24/FY4Q24 is around $300 million. Based on the COHR 800G optical module shipment volume and price obtained from my supply chain research, I estimate that the company's revenue for CY1Q24/FY3Q24 and CY2Q24/FY4Q24 can reach approximately $176 million and $355 million respectively, with FY3Q roughly in line with consensus expectations, and FY4Q likely exceeding expectations.

Details of my estimation by quarters/ by customers/ by products are shown in the tables below: