da-kuk
In the fall, I believed that Coherent Corp. (NYSE:COHR) was not sending a coherent message. Formerly known as II-VI, Coherent has been hurt by a combination of debt overhang and operational weakness due to lower demand. While the business could be a beneficiary of the AI/ML hype in the market, it was a non-inspiring 2024 outlook which did not send a coherent message to investors.
Shares quickly doubled in recent months, with underlying demand trends improving as the company seems to become a real beneficiary of the AI boom, expected to show up in the results in the coming quarters. This, and a capital-intensive Silicon Carbide business, having been isolated, providing real relief to investors here.
2021 – Start Of The Woes
It was the summer of 2021 when it became evident that II-VI was “winning” the bidding race for Coherent, leaving peers like Lumentum and MKS Instruments in the dust. In the end, the final deal tag rose to $7 billion, including a sizeable cash component, and thus assumption of debt. Coherent is the surviving business, at least the enduring name in this deal.
The idea was that a $3.1 billion business of II-VI was to be complemented by a $1.3 billion deal for Coherent, as the deal was quite strategic. However, in the end, it was the debt overhang which caused massive pressure on a nearly $100 stock of II-VI early in 2021.
By the time the final deal was announced, shares of II-VI were down to $60 per share already, granting the company an $8.3 billion equity valuation based on 138 million shares, as the deal only closed in July 2022. With the company already struggling, the company accepted $2.2 billion in mezzanine equity from Bain in order to manage leverage ratios.
Shares Tank
Through May 2023, shares had fallen to just $27 per share, as quarterly sales of $1.3 billion and change upon the consummation of the merger fell to just about $1.1 billion, with earnings seen under great pressure as well. Incurred (mezzanine) end leverage did not leave a lot of room for operational missteps and execution issues.
This came after fourth quarter sales for 2023 came in at just $1.21 billion, with adjusted earnings reported at $0.41 per share. For 2023, sales were reported at $5.2 billion, with adjusted earnings reported at $3.00 per share (aided by stronger earnings at the start of the year). Net debt remained very high at $3.5 billion, that is excluding $2.2 billion in mezzanine equity.
That should not have to be a huge problem, yet the guidance was rather underwhelming. For the first quarter of the fiscal year 2024, sales were seen at just $1.00-$1.10 billion, with adjusted earnings seen at $0.05-$0.20 per share. Moreover, full year sales for 2024 were seen at a midpoint of just $4.6 billion, with earnings seen around $1.00-$1.50 per share, making it very hard to get upbeat on the shares here.
The only bright spot was that Coherent announced that DENSO and Mitsubishi Electric combined would invest a billion to obtain a combined 25% stake in the silicon carbide business, valuing the unit at $4 billion, even as revenues of these cash-hungry activities come in at just a few hundred million.
Amidst all of this, I was a bit puzzled. This came amidst a heavy debt load and soft guidance, despite an upbeat share price reaction in response to AI and the news about the silicon carbide business. The lack of tangible results, or outlook, therefore, made me cautious at the time.
A Home Run
My caution from October had been way too cautious with the benefit of hindsight, as Coherent shares doubled to $62 at the moment of writing. In November, the company posted first quarter sales of $1.05 billion, with adjusted earnings coming in at $0.16 per share, largely in line with the guidance. The company did a guide for minimal improvements, with second quarter sales seen at a midpoint of $1.125 billion and adjusted earnings seen at a midpoint of $0.23 per share, while the full year guidance was maintained.
In February, it became apparent that second quarter sales came in at $1.13 billion, ahead on a sequential basis, but still down 17% year-over-year, with non-GAAP earnings reported at $0.36 per share.
Incremental improvements are seen, with third quarter sales seen at a midpoint of $1.16 billion, with adjusted earnings seen at $0.42 per share. This is driven by improving demand trends, expected to continue to improve on a sequential basis throughout fiscal 2024. On top of this good news, investors were pleased to hear that strategic alternatives were being pursued.
For the year, the lower end of the revenue guidance has been hiked, indicating that the full-year sales guidance (at the midpoint) has been hiked by twenty-five million to $4.625 billion, as 20-22% EBITDA margins should provide for a number around a billion dollars on this front, with adjusted earnings now seen at a midpoint of $1.50 per share. With net debt flattish at $3.4 billion, leverage ratios remain high but are likely coming down on a forward basis, although this still excludes a sizeable $2.3 billion mezzanine equity component as well.
And Now?
With shares having risen to the lower sixties, it is clear that valuations are readily expanding, as investors see greater upbeat developments to come, more so than the reported results and guidance indicate. On top of the strategic direction to vertically integrate the business with networking, lasers, and materials, Coherent has a few wild cards in the portfolio.
This includes the Silicon Carbide business as well as capabilities on 800G transceivers, which benefit from emerging AI data center applications. Revenues from these products crossed the $100 million mark in the most recent quarter, growing more than 100% on a sequential basis, as the company is already preparing commercial launch for 1.6T transceivers later this calendar year.
Right now it is clear that the shares have run hotter than the actual results, or near-term guidance suggests. That said, Coherent seems to have turned the corner, as improved earnings power from here will likely eliminate the remaining leverage concerns, but moreover, it really is the rapid growth in the transceivers which ignites the imagination with investors, and leaves an upside to the guidance. This is certainly the case, as the large AI component to the growth sparks imagination among investors.
This created a great run in the shares, and certainly in the immediate reaction to the fiscal second quarter earnings report, with shares now back to the levels last seen in the summer of 2022. Amidst all this, Coherent Corp. momentum is clearly moving for the positive, but to buy the rally, one really has to have conviction here. While there are many positive signs, this all still has to show up in the results.
Not feeling the urge to chase Coherent Corp. shares here, I still appreciate the strong underlying trends, but I am taking a wait-and-see approach here.
