Sept. 8, 2020

In our August 2020 Research Note, we said the industry appeared to be growing ahead of expectations in Q2. Now in September virtually all the Q2 data is in, and it confirms that Q2 was a very strong quarter for many if not all the companies in the communications industry. Demand for optics was very strong across the entire market with cloud datacenters and 5G deployments areas of particular strength.

However, the outlook for Q3 is not looking as bright as it was previously. One cloud blocking the sunshine is that some companies that reported great Q2 numbers – Cisco and Ciena in particular – guided for lower revenues in Q3.

0920 Research Note

On the Ciena earnings call, Gary Smith explained Ciena’s outlook this way:

“A combination of factors [are driving deceleration in the second half]. There is a certain amount of pull forwards [orders for Q3 fulfilled in Q2]. We had a number of carriers who were in a position to secure continuity of supply, [by placing] orders. We had very strong Q2 orders. [The other factor is, network operators] are not prioritizing new route wins and new adoption of technology generally. They're focused on keeping the network going and running it a little bit hotter. And some enterprise customers in sectors such as retail, transportation, hospitality, restaurants [are] really suffering significantly, and that's beginning to impact the outlook. So overall the outlook on second half of 2020 is determined by these three elements coming together.”

Another rain cloud darkening the Q3 outlook is the escalation of the China-U.S. trade war and the impact of the U.S. ban on semiconductor sales to Huawei on 5G deployment. It looks like this will seriously reduce China’s 5G deployment in Q3, and associated fronthaul transceivers along with it.

China has been a leader in 5G deployment and China Mobile and China Telecom/Unicom together had planned to deploy more than 500,000 base stations in 2020. Since the U.S. government banned the sale of semiconductors made using U.S. sourced equipment to Huawei, the company purchased all the semiconductors it could and built inventory, enabling it to continue making base stations for a period of time. Now however it looks like production is grinding to a halt, causing 5G deployment by the mobile operators to come to a halt as well. And as a result of this, Chinese vendors who were supplying 10G and 25G optical transceivers for fronthaul have seen orders plummet in Q3. Many of these companies, including Accelink and Innolight, reported record revenues in Q2 2020 – up around 50% y-o-y. New records will have to wait until 2021, given the gloomy outlook for the rest of 2020.

Chinese service providers, interviewed by LightCounting at Optinet China (one of the first post-COVID events, held in Beijing last week), were optimistic about the Huawei situation. They expect the company to find other options for sourcing components and resume production of base stations in 2021. More than 600,000 of base stations are expected to be deployed in China next year.

The latest set of restrictions on Huawei announced by the US government 2-3 weeks ago is likely to have a negative impact on a broader range component vendors. There is a lot of confusion related to the new restrictions and the suppliers are still figuring out what these really mean for their business.

While the coronavirus pandemic is raining on Q3 and possibly Q4 2020 results, we continue to believe that the communications industry will weather the storm without significant damage from it. Treatments and vaccines for COVID-19 are coming and will afford the world a return to normalcy at some point in 2021. Many of the accelerants of network traffic growth seen in 2020 – work-at-home, learn-at-home, shop-from-home – will continue after the pandemic has ended.

When the winds of change will drive away the second dark cloud hanging over the industry – the U.S. ‘war’ on Huawei – is much more difficult to predict. It depends at least in part on the outcome of the presidential election in November. How much damage and industry restructuring will take place as a result before there is a policy shift (if ever) is impossible to predict with confidence.

Full text of the research note is available to LightCounting clients at:https://www.lightcounting.com/auth/login


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