AAOI Investment Value Deep Dive

Currently, the demand for InP-based Continuous Wave (CW) lasers in the optical communication field is surging, directly leading to an extreme shortage in market supply. In this context, the main competitors in the industry are facing severe challenges: Lumentum, constrained by InP supply bottlenecks, has been forced to reduce its client list; while Coherent plans to prioritize its internal laser capacity to meet its own product needs. This situation means that module manufacturers lacking internal chip manufacturing capabilities are facing a real risk of supply disruption. In stark contrast, AAOI has successfully transitioned the majority of its laser production processes to in-house research and production, thus gaining control in the supply chain.

In response to strong demand from core clients like Amazon for 800G and future 1.6T optical modules, AAOI is actively deploying capacity expansion, with its internal laser capacity forming the cornerstone of this strategy. Currently, AAOI's wafer fab in Houston produces approximately 200,000 CW lasers per month. The company has established a clear upgrade roadmap, aiming to significantly increase monthly production capacity to 2.4 million by the end of 2026 by introducing new equipment and upgrading wafer sizes from 2-4 inches to 6 inches. When considering the production capacity of over 3 million SiPho pump lasers each month, this scale means that the laser chip segment will no longer be the bottleneck restricting AAOI's optical module production growth. In contrast, many competitors may find themselves passive due to insufficient upstream chip supply when expanding module assembly lines.

Strategic barriers of domestic manufacturing in the U.S.: In an increasingly complex geopolitical landscape and an environment filled with uncertainty over tariff policies, AAOI possesses not only module manufacturing capabilities but, more importantly, the ability to produce core laser chips domestically in the U.S., which grants the company a high strategic value. AAOI is currently one of the few suppliers that can manufacture EML and CW lasers on U.S. soil. Cloud service giants like Amazon or Microsoft, in order to ensure supply chain diversity and security and to hedge against risks that Asian supply chains may face, are often willing to pay a premium for such domestic suppliers.

Potential Opportunities and Challenges Analysis

Upside Risks

1. Volume growth of 800G/1.6T products driven by large customer orders:

If the capacity expansion plan set by the company can be smoothly implemented, for example, achieving a monthly capacity target of 100,000 800G modules by the end of 2025, this will directly drive significant revenue growth for the company.

2. U.S. manufacturing dividends amid geopolitical dynamics:

Tightening geopolitical relations and tariff pressures are prompting hyperscalers to shift their supply chains away from Chinese manufacturers. With its domestic manufacturing strength, AAOI is expected to capture more market share from Chinese competitors like Innomlight.

3. Cost optimization and profit enhancement brought by automation technology:

The high level of automation at AAOI's Texas facility is remarkable, significantly reducing labor demand by 85%. This move not only effectively addresses the challenge of high labor costs in the U.S. but is also expected to yield gross margin performance exceeding market expectations.

4. Recovery of cable TV CATV business and Charter's upgrade cycle:

AAOI is benefiting from the network upgrade plans promoted by cable TV operators like Charter (involving DOCSIS 4.0 and 1.8 GHz amplifiers). This segment is performing strongly, with revenue exceeding expectations, providing the company with solid cash flow support.

Downside Risks

1. Uncertainty in execution and capacity expansion (core concern):

Regarding yield and delivery: The manufacturing process of optical modules is extremely complex, and fluctuations in yield and cost differences are the norm. Historically, the execution capability of AAOI's management has been inconsistent, and large-scale capacity expansion presents enormous operational challenges. Furthermore, the qualification timeline for customers (especially Amazon) is uncertain, and any delays in any aspect may lead to a postponement of revenue recognition, while the company must bear high expansion costs in advance.

2. Risk of over-reliance on a concentrated customer base:

AAOI's revenue is highly dependent on Microsoft, Amazon, and Charter (through agents like Digicomm). Losing any major customer or a sudden slowdown in demand due to adjustments in AI capital expenditures could severely impact the company.

3. Financial condition and equity dilution risks:

Regarding equity dilution and debt issues: To raise funds needed for capital expenditures (Capex), AAOI has conducted multiple ATM offerings and issued convertible bonds. This has led to a doubling of share capital, inevitably diluting the earnings per share for existing shareholders.

4. Risks of technological iteration and replacement:

Potential threats from CPO co-packaged optics: From a long-term perspective, CPO technology has the potential to replace traditional pluggable optical modules. If this technology is deployed in hyperscale data centers faster than the market expects, AAOI's existing product line will face obsolescence pressure. However, considering that this technology is not expected to mature until after 2028, there is currently no need for excessive concern.