Why do companies making semiconductor-scalable photonics products garner strong investor attention and more traditional component and instrument firms not keep pace? Understanding the answer to this question is important to new photonics entrepreneurs, to seasoned executives, and, in fact, to the broader photonics community. It’s important because the motivations and timing of investment markets are often misunderstood, resulting in unrealistic expectations.
At the core of these investment markets are venture capitalists (VCs) and other equity investors who want their portfolio firms to have above-average growth, a management that has a depth and history of scaling business, and a business model that produces recurring revenue. If these traits are not in evidence, then investors ignore a sector and the firms that don’t fit their focus.
Photonic integrated circuits (PICs) and sensor-driven photonics components check the boxes of having big-market potential and of leveraging semiconductor scaling. As a result, companies that make these components are attracting flocks of global investors. A related approach for some investors is to find photonics companies that can scale by including software and recurring revenue from value-adds; e.g., Cognex and Illumina are great examples of this model from the recent past. In today’s investment markets, makers of lidar and quantum systems are seen as part of this new generation of firms worth backing.
Capital injections and hyper-returns in photonics—a short history
At SPIE Photonics West this year, the great enthusiasm for photonics reminded me of the story of how the investment bank where I was a Managing Director took public Uniphase (now effectively Lumentum and Viavi). Before the original Uniphase initial public offering (IPO) in 1993, the company was far from a darling that attracted droves of investors, despite being profitable and growing nicely, with lasers that were leading the market in their niche industrial segments. And yet the hottest IPO at the time was Boston Chicken, while we struggled to get investor demand because lasers were considered too small a market and slow growth for many investment funds to own.
By the late 1990s, the telecommunications boom was requiring massive numbers of lasers and Uniphase had become a darling of public investors, both before and after the 1999 JDS Fitel/Uniphase merger that produced JDSU. The merger helped drive the billions of dollars invested by VCs in every company with technologies and products related to optical communications—that is, until the sector flew into a wall.
Many other photonics component companies rode this wave of investor pull, driven by carrier buys, acquisitions by system-level firms, and the valuations of companies like Ciena, Cisco, and Nortel. As a long-term benefit, the investor wave fueled innovations that spilled over into fields like medical and industrial lasers and optics.
The point to remember is this: nothing has changed since then about how investors think. In other words, 1) they want to make money as easily as possible; 2) they don’t care about technology for its wonder; 3) they need “comparables” or benchmarks against which to compare any given company; and 4) an investment needs to be relatable and relevant for the hyperactive, short-attention-span mind of a typical investor. These investors move in and out of hot sectors very quickly.
Photonics is drafting on lidar and quantum
Lidar has been a hot ride for a few years, with an estimated 100 manufacturers getting VC funding or being acquired. However, the news hype implying that lidar will be built into every one of the 100 million cars produced annually will not happen anytime soon, and perhaps never given all the regulatory hurdles, total system costs, and consumer behavior to be modified. Quantum has been riding a similar wave with the promise of fighting a global supremacy battle for information advantages, yet it is still clearly a multiyear, foggy road to obtain useful content.
Why are investors flocking to these technologies now? It isn’t respect for physicists doing cool things—rather, it’s just another a play on Big Data and AI, markets where investors have raked in rewards during the past decade by investing in Internet and data-oriented firms. These markets are the “comparables” that are driving this investment wave. Photonics firms have helped enable the wave, but they have only picked up crumbs in investment returns.
Can photonics firms move up the value-add chain by adding in AI to produce a big investment win, or are they going to settle for being an instrument or component player that gets whipped with the cycles? My favorite example of a photonics firm that has captured a premium add-in value is Illumina, which at its founding brought in a team of biologists to take forward the value of the core fiber-optics technology to produce a complete solution of systems, software, and recurring revenue.
In a similar way, some photonics components companies are trying to play into a very large, well-developed, and data-intensive mass market with new photonics solutions that expand or transform that market. It can be a winning formula for producers of PICs/silicon photonics, VCSELs, or related mobile phone optics. Producers like Sunny Optical and Largan have grown rapidly over the past few years by delivering scalable semiconductor processes into applications.
No wave? Here’s how investors see you
Depending on your tolerance for risk and disappointment, you may be perfectly happy not riding a wave. In a hyper-growth, large-market-focused investment market, the VC-driven model means that for every investment that catches a wave to eye-popping highs, eight to nine will crash and burn.
The majority of private and public photonics companies are what is termed by investors “lifestyle firms”—capable of being self-sustaining with modest growth. These firms do not attract VC investment, and the path forward for these small firms is to be acquired for multiples in line with well-known metrics of similar industrial firms, in the range of 5–9x earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples. Even among the larger firms, for example, Rofin and Newport were acquired a few years ago for typical public industrial multiples of 10x EBITDA or MV/Revenue of ~1.6x.
In the photonics community, Corning is a highly regarded leader. For equity investors, with its MV/Revenue of under 2x and recent MV/EBITDA of 7.5, Corning is seen as a good dividend play, not growth. Before the recent stock selloff in March 2020, its stock finally matched its 2008 highs. In contrast, as of late February 2020, the PHLX Semiconductor Sector Index (SOX) had 5x appreciation since its 2008 peak. In similar fashion, most investors no longer classify the industrial laser sector as a growth play.
Recent investment trends in photonics might confuse some observers. With investors flocking into lidar, quantum computing, VCSELs, and new sensing modalities, along with the recent buyouts of silicon photonics firms, these observers might see confirmation that the photonics sector is finally being appreciated. Yet, it’s got nothing to do with technology. Instead, it’s all about how much of a return is projected, how much can you grow, can you scale efficiently, and whether you will achieve high and sustainable profits.
One reason the semiconductor and software sectors attract attention is that they are leaders in productivity, with very high revenue per employee, which enables scaling and higher margins—in contrast to most photonics businesses. In recent years, average revenue per employee for semiconductors and software has been in the $500,000–$630,000 range, while for electronic instruments, it is in the range of $217,000 to $390,000, consistent with data that the OSA has noted for photonics firms. If you can’t yield returns better than the comparables within the time windows of investors, expect investment funds to fly away whenever storm clouds blow.
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