ADVA Optical Networking Initiation Of Coverage

ADVA Optical Network (ADV.BE)is a niche player in the global optical equipment market. Growth is driven by investment in next generation networks (NGNs) due to the explosion in data volumes. Unlike its peers, it has no exposure to legacy technologies and its revenue growth is industry leading. Growth drivers are becoming more diverse and if it delivers on strategy, we see upside earnings risk. Despite this, it trades at a discount to peers.

Outlook: New market opportunities
ADVA offers solutions for operators and enterprises compelled to increase bandwidth at lower costs to meet the explosion in demand for data. It is in the unique position of having no exposure to legacy technology. It operates only in the high growth niches of optical and Ethernet transport solutions, enabling growth well above its peers. In a tough market, the outlook is promising.

Commercial necessity should ensure that demand remains underpinned by the fixed networks and enterprise markets, while new market opportunities should provide a stimulus to growth:

1) with its number one market share, ADVA is well positioned to benefit from the potentially significant mobile backhaul sector; and

2) ADVA’s recent moves into two new segments of Ethernet aggregation and long-haul Wave Division Multiplexing (via its partnership with Juniper Networks) significantly increases its addressable market. Although visibility in these new markets is limited, they should provide a strong support to revenue growth.

Forecast assumptions: 19% three-year CAGR in EPS
The three-year CAGR in revenues to 2011 is 13% and ADVA had a strong start to 2012 with H1 revenues up 13% and gross margins up 3pp to 40.2%. Given the tough economic and competitive backdrop and the lack of visibility on the mobile backhaul market and new product ranges, we are fairly cautious in forecasting, with revenue and margin growth behind industry expectations for its end markets. Despite this caution, our three-year EPS CAGR forecast is 19%.

Valuation: Discount to peers despite higher growth
Despite its superior growth and strong balance sheet, on a P/E of 13.2x ADVA trades at the low end of peers and at a 50% discount to its closest competitor (Ciena). Our core DCF is €6.27 (€7.68 if ADVA grows revenues in line with forecasts for its end markets of 13%).

Dependence on key partners and so few products in a market dominated by much larger companies does present risks. However, given the strong H1, new products and the possibilities emerging in mobile backhaul, on balance, we see earnings risk to the upside. News on progress in these new areas could provide a catalyst for upgrades or a re-rating. ADVA has an investor day on 19 September.

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