Ban on U.S. companies selling to China’s ZTE could really bite this stock

It’s never good when you’re suddenly banned from selling to a major customer.

That’s the position Acacia Communications Inc. ACIA, -35.97%  is in Monday after the U.S. Commerce Department said it would prohibit American companies from supplying components to Chinese hardware firm ZTE Corp. 000063, +0.35%  for seven years. Acacia shares are off 38% following the report of the ban, which stems from ZTE’s past violation of Iran sanctions and its refusal to punish involved employees as it had promised.

The ban is a clear “negative” for Acacia, according to MKM Partners analyst Michael Genovese, who has a neutral rating on the stock. The company said in its latest annual report that it generated 30% of its revenue in 2017 from ZTE. Other optical names that sell to ZTE might be better positioned because they also sell to Huawei and Nokia Corp. NOK, +1.63% Genovese reasoned, as these two hardware manufacturers are likely to gain optical market share at ZTE’s expense “since ZTE can no longer purchase cutting edge components.” But Acacia has limited exposure to Huawei and Nokia.

See also: Facebook is leaving the technology sector, and that may be good news for tech investors

Shares of these other optical names are getting slammed in sympathy with Acacia, but Genovese suggests that many of these reactions could be overblown. He recommends buying the dip on Lumentum Holdings Inc. LITE, -9.06% whose shares are down 6.6% in Monday’s session. Lumentum gets about 15% of its revenue from Huawei and only 2% or 3% exposure to ZTE, per Genovese. “Currently the big 100+G project in China is the China Telecom Metro build, where Huawei already has 70% market share and Lumentum is the primary ROADM vendor.” (ROADM refers to reconfigurable optical add-drop multiplexer.)

He also sees a buying opportunity in shares of Oclaro Inc. OCLR, -15.18% currently down 15%. Lumentum is in the midst of acquiring Oclaro and Genevose doesn’t foresee Lumentum revising its offer price downward. Oclaro generates about between 10% and 15% of revenue from both Huawei and ZTE and gets another 10% from Nokia. Genevose deems it unlikely that the Chinese government will seek to block the deal as a result of the sanctions.

“Huawei is closely associated with the Chinese government, and Huawei and ZTE strongly dislike each other according to our checks,” he wrote. “We do not think Huawei or the Chinese government are overly concerned about U.S. sanctions against ZTE.”

Shares of Finisar Corp. FNSR, -4.05%  are off 4.1% in Monday’s session, but even though the company is more exposed to Huawei than to ZTE, Genevose is hesitant on the stock for reasons unrelated to the ZTE ban. “While the move on the news looks overdone, we think it is still too early to pound the table on Finisar since we cannot yet tell when the company’s bottom for gross margins in this cycle will occur,” he wrote.

Genovese rates Finisar, Lumentum, and Oclaro all at buy.

With Monday’s drop, Acacia’s stock is one of the biggest losers in tech over the past year. Acacia shares are down 53% over the past 12 months, while the S&P 500 SPX, +0.81%  has gained 15% and the Dow Jones Industrial Average DJIA, +0.87% has added 20%.

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