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Oclaro And The Convertible Notes Story: Has Too Much Been Given Away?

Summary

This article looks at Oclaro's Convertible Notes which mature February 2020.

Given the stock price since the issue, from $1.46 to around $5, are these notes a ticking bomb?

Share count looks to increase by 30% this year, diluting exiting shareholders.

Despite starting 2014 "virtually debt free," is the situation getting out of hand?

Briefly.

  • In February 2015, Oclaro (NASDAQ:OCLR) sold convertible notes to raise $65m to keep the company going while revenues were slack and insufficient to cover costs.
  • Last quarterly earnings (Q3 FY2016) showed Oclaro has just broken even.
  • Share price has risen so much higher than the notes' conversion price, buying back the notes is not affordable.
  • New shares will be issued to note holders diluting existing shareholders by 30%.
  • Insiders continue to add shares and no note holders have yet converted. Could confidence in Oclaro's future really be this high?

I have been an Oclaro shareholder for nearly three years and this is my attempt to understand the impact of the company's convertible notes. In the process I think I have found a substantial implied positive sentiment for the company's future.

Turning Oclaro into a profitable leader for the latest, fastest optical networks.

Oclaro is a designer and manufacturer of optical networking transceivers and cables. The company is around a third of the size of its largest competitor (Finisar (NASDAQ:FNSR)) but is by no means the smallest of quoted companies in this sector.

Company name

P/E ratio

Mkt Cap ($m)

FNSR

Finisar Corporation

58.12

1700

VIAV

Viavi Solutions Inc

1460

LITE

Lumentum Holdings...

1340

Oclaro, Inc.

480

NPTN

NeoPhotonics Corp

69.98

396

AFOP

Alliance Fiber Op...

38.17

293

AAOI

Applied Optoelect...

15.33

161

EMKR

EMCORE Corporation

95.26

136

Click to enlarge

Oclaro's management is in the process of returning the company to profitability mainly by focusing on the advent of 100G speed optical networks. Oclaro makes the cables and transceivers used by telecom and datacom (datacenters) companies for the fastest parts of their networks.

Source; Oclaro presentation Northland Capital Markets 2016 Growth Conference.

This has been a long hard slog so far with divestments of divisions, laying off 50% of employees, and many other painful decisions made to turn the company around. This includes a 15% pay cut for executives and board members which is not something you hear every day.

However, judging by the stellar performance of the share price over the last 18 months, these actions are having the desired effect and investors are happy with the results.

Use of debt to cover running costs

Over the years, Oclaro has made use of debt facilities, share issues and convertible bonds to keep the company alive during loss making periods. So far, the experiences have been mixed.

For example, in December 2012 Oclaro issued $25m of convertible notes paying interest at 7.50% per annum, raising approximately $22.8m. Note holders exercised these notes in December 2013 when the share price was around $2.20. With an exercise price of $1.85, note holders made a decent profit, the company was not too stretched with a redemption payment of $8.3m, and existing...


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