Coherent's Photonics S-Curve: Scaling the AI Infrastructure Layer

The shift from electrical to photonic interconnects is no longer a future possibility; it is the fundamental engineering challenge of today's data centers. As AI workloads demand unprecedented bandwidth, the physical limits of copper are being reached. This creates a clear technological S-curve, where the next paradigm is built on light. Coherent Corp. is positioned squarely at the foundational layer of this transition, manufacturing the critical components that form the nervous system of AI infrastructure.

The driver for this acceleration is the explosive demand for higher-speed transceivers. Hyperscalers are racing to upgrade their networks to handle AI-driven workloads, with strong Datacom demand for high-speed optical transceivers-particularly 800G and 400G modules. The industry is already looking beyond that, with a 1.6T optical transceiver from Coherent representing the next frontier. This isn't just incremental improvement; it's a step function in data transmission capacity required to move massive AI model parameters efficiently. Coherent's first-quarter results show the payoff, with its Datacenter Communications segment delivering 26% year-over-year growth, fueled by record bookings for these high-bandwidth products.

What gives Coherent a durable advantage is its vertical integration in a key raw material: indium phosphide lasers. The company has built a 20-year indium phosphide platform and is now scaling it through the world's first 6-inch production lines. This internal capacity creates a powerful moat. When supply constraints emerge, as they have for these critical lasers, they signal intense demand strength rather than weakness. This positions Coherent to command pricing power as customers compete for limited capacity. The financial impact is clear, with the company's gross margin improving 358 basis points in FY25 and a clear path to a >42% long-term target.

In essence, Coherent is not just selling components; it is building the infrastructure layer for the AI paradigm. Its vertical integration in indium phosphide gives it a supply advantage that is critical as the industry ramps toward 1.6T and beyond. The company is no longer a niche player but a foundational supplier in the exponential growth phase of AI datacenter interconnects.

Financial Execution: From Turnaround to Exponential Growth

The financial recovery is now a clear trajectory. After a difficult 2024, Coherent is set for a sharp turnaround, with revenue projected to rise +23% year-on-year to $5.9 billion in 2025. This rebound is not a broad-based recovery but a targeted acceleration in its core AI infrastructure business. The Networking division is expected to lead the charge, with sales forecast to surge 48%, driven entirely by the insatiable demand for high-speed optical transceivers. This is the pure-play growth engine of the AI S-curve.

The company's execution is translating directly into profitability. A key metric of operational leverage is the gross margin, which improved by 358 basis points in FY25. This dramatic expansion is the result of vertical integration in indium phosphide lasers, yield improvements on new 6-inch production lines, and pricing power secured by supply constraints. Management has set a clear long-term target, aiming for a gross margin of greater than 42%. Achieving this requires flawless scaling of the new capacity, but the path is now visible and financially compelling.

This financial turnaround is being anchored by a strategic repositioning. At its recent Analyst Day, Coherent outlined a new segmentation and long-term financial model focused on its key markets. The goal is to drive double-digit revenue growth in its key markets, such as AI Datacenters. This shift in focus, coupled with the divestiture of lower-margin businesses, streamlines the company to concentrate capital and management attention on the exponential growth phase of photonics. The result is a more focused portfolio where the financial model is explicitly tied to the adoption curve of AI infrastructure.

The sustainability of this growth hinges on the company's ability to meet the demand it is creating. The 48% growth forecast for Networking is backed by record bookings for 800G and 1.6T transceivers, with customer forecasts extending through 2028. However, the risk remains in the execution of the 6-inch indium phosphide ramp. Any delay or yield issue could disrupt the supply advantage that is currently fueling margin expansion. For now, though, the financial setup is strong: a powerful growth engine in AI datacenters, a clear path to premium margins, and a disciplined capital allocation strategy. The company is transitioning from a turnaround story to one of scaling a foundational technology.

Scaling the S-Curve: The 6-Inch InP Milestone and Multi-Rail Catalyst

The next phase of Coherent's growth hinges on its ability to lead the next adoption curve, not just by building more capacity, but by innovating how that capacity is delivered. The company's recent demonstration of multi-rail technology at OFC 2025 is a prime example of this forward-looking engineering. This solution, which combines two independent rails carrying C-Band signals within a single 1RU module, represents an immediate doubling of density. In a world where data center space and power are finite, this sublinear scaling is critical. It allows hyperscalers to meet surging bandwidth demands without a proportional increase in physical footprint or energy consumption, effectively extending the life of their existing infrastructure.

What makes this catalyst particularly potent is Coherent's unique position in the market. The company is the only vendor demonstrating three different 1.6T transceiver architectures. This breadth of innovation signals deep technical mastery and a first-mover advantage in the race to standardize the next generation of optical links. While competitors are still grappling with the 800G transition, Coherent is already showcasing multiple pathways to 1.6T, giving it a significant lead in both technology and customer engagement. This technological moat is directly tied to its vertical integration, as the company's internal indium phosphide laser production provides the specialized components required for these advanced designs.

The path from demonstration to commercial impact is now clear. General product availability for these key innovations, including the multi-rail platform, is anticipated in the first half of 2026. This timeline aligns perfectly with the company's own capacity ramp. The 6-inch indium phosphide lines are scaling, and the new multi-rail technology will leverage that expanded capacity to deliver exponential gains in system-level performance. The bottom line is that Coherent is not merely scaling its current business; it is deploying a multi-pronged attack to capture the next wave of adoption. By solving the density and power constraints of today's networks while simultaneously leading in the 1.6T transition, the company is positioning itself to command a disproportionate share of the infrastructure buildout as the AI paradigm enters its next, more complex phase.

Valuation, Catalysts, and Risks: The High-Growth Trade-Off

The investment case for Coherent now rests on a clear trade-off: high growth expectations priced in, but a long runway to meet them. The stock's current valuation reflects strong analyst conviction, with an average price target of $246.66 implying over 32% upside from recent levels. However, the market is also pricing in patience, as the average time for these targets to be met is nearly two years. This setup is typical for a company scaling a foundational technology-it demands belief in the long-term S-curve, not just quarterly results.

The near-term catalysts are tangible and aligned with the company's roadmap. The first is the commercialization of its multi-rail technology, with general product availability anticipated in the first half of 2026. This solution, which doubles density within a single rack unit, is a direct answer to the physical constraints of AI data centers. Its successful launch will be a key signal of Coherent's ability to deliver on its promised efficiency gains. The second major catalyst is continued strong demand, evidenced by record bookings for 1.6T transceivers. The company's Datacenter Communications segment delivered 26% year-over-year growth last quarter, and sustained momentum here is critical for validating the growth trajectory.

Yet, the path to those targets is not without friction. The primary risk is execution on the technology ramp. Scaling the new 6-inch indium phosphide lines and integrating advanced platforms like multi-rail requires flawless operational discipline. Any delay or yield issue could disrupt the supply advantage that is currently fueling margin expansion. A second, more cyclical risk is the potential for weakness in non-AI segments. While AI datacenter demand is surging, the company's Materials segment is forecast to decline, and the broader Electronics and Instrumentation markets are expected to remain subdued. This creates a vulnerability if the AI infrastructure buildout experiences any pause. Finally, competitive intensity in the photonics supply chain is a constant. As the market for high-speed transceivers grows, more players will enter the fray, testing Coherent's pricing power and its ability to maintain its technological lead.

The bottom line is that Coherent is a high-conviction, high-risk play on the AI infrastructure S-curve. The valuation premium is justified only if the company can navigate the execution hurdles and maintain its technological edge. For investors, the thesis hinges on the successful commercialization of its density solutions and the sustained strength of AI-driven demand, all while managing the cyclical headwinds in its broader portfolio.