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Why NeoPhotonics Shares Are Plunging Again on Friday

Lou Whiteman, The Motley Fool

What happened

Shares of NeoPhotonics (NYSE: NPTN) fell more than 20% on Friday after falling by a similar percentage on Thursday as the markets continue to digest the company's potential exposure to the U.S. government's ongoing trade war with China and its crackdown on Chinese telecom equipment giant Huawei Technologies.

Friday's fall follows analyst downgrades that suggest the situation could be as dire for NeoPhotonics as investors initially feared.

So what

NeoPhotonics has been in a free fall following a decision by the U.S. government to designate Huawei as a company engaged in activities that are contrary to U.S. interests. The designation restricts Huawei from buying equipment or licensing technology from U.S. companies.

Two crates suspended from hooks, painted with the flags of the United States and China, crash together.

Image source: Getty Images.

Given that Huawei accounted for about 44% of NeoPhotonics' sales in the most recent quarter, the move could be devastating to the supplier's outlook. The designation caused Needham analyst Alex Henderson to downgrade NeoPhotonics to a hold from a strong buy, with Henderson writing that while there is a chance NeoPhotonics could be granted an exemption, the potential implications for the company are too big to be ignored.

NeoPhotonics was also downgraded to neutral from buy at MKM Partners and assigned a $4.50 price target.

The MKM Partners downgrade seems particularly noteworthy because on April 30, the firm had initiated the company with a buy rating and a price target of $9 per share. Analyst Michael Genovese at the time acknowledged NeoPhotonics' customer concentration but concluded Huawei was unlikely to be banned from buying U.S. components.

Now what

In his update, Genovese sees a 50% probability that the Huawei ban is permanent and not just a negotiating bargaining chip but admits this could be a "great buying opportunity" if the issues get worked out in trade negotiations.

Company CEO Timothy S. Jenks on a call with investors back in March argued that Huawei's huge share of NeoPhotonics revenue is reflective of Huawei's dominant position in the market, noting that NeoPhotonics does business with Huawei's competitors as well. If that is the case, investors could hope that a ban on Huawei gear would shift demand to other vendors, at least in the U.S., lessening the overall revenue impact for NeoPhotonics.

Of course, that argument falls apart if the rest of the world keeps buying Huawei gear. Either way, it's a long shot at best. Investors are voting with their feet on Friday, concluding there are better stocks to buy instead of taking a gamble on NeoPhotonics.

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Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.