SOROS FUND WARMS TO QUEBEC’S EXFO
Billionaire hikes stake in firm amid growing thirst for data
A company that was off the radar of most Canadian investors that don’t follow the small cap technology space is getting a bit more attention these days, courtesy of one of the world’s most prominent business magnates.
Quebec City-based Exfo Inc. has received a share price boost since a Dec. 21 filing showed that billionaire George Soros hiked his stake in the company to 5.8 per cent. That was up from 3.8 per cent at the end of September.
While an endorsement such as this often convinces others to get on board, it doesn’t hurt that Exfo’s financial performance continues to improve, and it’s a play on the insatiable thirst for data among consumers in North America and beyond.
Soros is no stranger to the optical networking industry, as his Quantum Strategic Partners investment vehicle provided financing for Hyperoptic, a company that provides high-speed lines to homes in the U.K.
Exfo operates in a slightly different segment of the industry, providing testing equipment and services for wireless and wireline networks. It struggled with execution in 2014 and 2015, and that caused it to lag other optical stocks, which surged last year as investors jumped aboard the theme of a growing Internet, and the race to build faster telecom networks around the world.
Tom Antony, president and portfolio manager at Peregrine Investment Management, noted that an investment by Soros is certainly a vote of confidence for Exfo, although a 5.8 per cent stake represents a very small holding.
Soros Fund Management has a portfolio that is estimated at $US30 billion.
“The Soros people are very smart,” Antony said. “If there is a bull argument on the stock, it would be that Exfo is going to benefit from the rollout of 100G transmission networks that has driven a lot of the optical stocks.”
However, as a test and measurement company, Exfo’s drivers are not identical to the other optical companies, so it hasn’t seen the same type of hyper-growth seen in the late 1990s. That was when networks were being built, people thought the Internet was going to be infinite in size, and there was overcapacity put in as a result
“It doesn’t have the torque of companies making the new generation lasers and systems, but it appears to be benefiting somewhat, as they are certainly doing better in the past few quarters,” Antony said.
Exfo reported an 11.9 per cent year-over-year revenue increase when it released first quarter results for fiscal 2017 on Jan. 10. That was ahead of both guidance and analysts’ forecasts, as the company continues to benefit from the 100G optical upgrade cycle.
Earnings per share also exceeded expectations, due to stronger revenue and ongoing cost-containment efforts during the past year.
Management highlighted continued capital deployment from telecom operators into data centres, along with 4G capabilities and preparation for 5G somewhere between 2018 and 2020.
“Exfo offers a solid and differentiated network testing and monitoring product portfolio and stands to benefit from increased capital expenditures and constrained network environments,” said Steve Arthur, a high-tech analyst at RBC Capital Markets.
Higher-quality websites, mobile data applications and HD video streaming are fuelling the rapid growth in global broadband demand, but that is putting a strain on network capacity.
That’s a big reason why more capital investment is needed to maintain network integrity and feed fast Internet speeds to businesses and individuals alike.
“Capital spending, which has really been restrained for the past several years, has a chance of re-accelerating under a better growth, higher inflation expectation environment,” said Andrea Horan, portfolio manager at Agilith Capital.
The firm has owned Exfo for more than five years, and roughly doubled its position as the stock hit new lows.
“Exfo is very well-positioned as the leader in optical test equipment,” Horan added, noting the company has a stronghold with North American carriers, and has a global presence with China being an important customer.
The rollout of networks in China, which is larger in scale than ever before, is another factor that has pushed optical stocks higher in the past year.
Exfo is listed on both the TSX and Nasdaq, but its market cap of only about $325 million is in part, why the stock is covered by just six analysts, one of which is based in the U.S.
Like others, U.S. investors look at for leaders and laggards in the optical space. Since Exfo has been a laggard and is often overlooked, as the investment cycle gains steam and well-known optical stocks run up, more U.S. investors may look north of the border.
Thanos Moschopoulos at BMO Capital Markets maintained a neutral rating on Exfo following the Q1 results, but he’s admittedly warming up to the story.
“Exfo’s execution is improving, and the uptick in growth seems to have some legs,” the analyst said.
Exfo also boasts a strong balance sheet with net cash of approximately $40 million, that offers flexibility for organic growth initiatives and acquisitions, in addition to hidden assets in the form of intellectual property that are difficult to replicate.
Another potential boost could come from a leadership transition, as current chief executive, chairman and founder Germain Lamonde, is expected to hand the reins over to chief operating officer Philippe Morin sometime in 2017.
Morin ran Nortel Networks’ optical networking business, which was considered the company’s crown jewel when it was sold to Ciena Corp. He continued in that role at Ciena until making the move to Exfo in November 2015.
It’s also worthwhile to note the rather large short position in Exfo shares — more than one million shares on Canadian exchanges alone. That’s nothing new, as even a year and a half ago, shorts on the stock were as high as 900,000 shares.
Exfo only trades about 50,000 shares a day in Canada and the U.S., which has Horan anticipating a potential lift as sentiment improves toward the name.
“At some point, this could get seriously squeezed,” she said.