Why a $200 million indium phosphide market matters to AI
This is the core paradox: just over $200 million is the entire global market for indium phosphide wafers, yet the material sits at a key point in AI infrastructure. It supports the lasers behind optical interconnects, so any disruption can ripple through data-center buildouts much larger than the substrate market itself.
China's export controls turned scarcity into a near-term risk
China added indium phosphide to its export control list in February 2025, requiring permits for overseas shipments. According to industry commentary, epitaxial fabs hold only weeks of inventory, so licensing delays can quickly affect production and shipments.
The issue moved from theory to policy quickly. Coherent warned of an indium phosphide shortage in early May, and by June its CEO was traveling to China partly to raise delays in China's export licenses. That sequence shows how a niche material can become a live bottleneck for AI optical supply chains.
Coherent has demand, but shipments still depend on permits
The key question for Coherent is not whether demand exists. It is whether the company can convert that demand into shipments quickly enough to support the next earnings improvement.
Strong demand and improving margins do not tell the full story
Coherent's latest quarter shows a business with real demand, not weak customer interest. The company reported $1.58 billion in revenue and a 38.7% non-GAAP gross margin, with expansion tied to pricing optimization, cost reductions, and yield improvements.
The segment split explains the bottleneck. Data center revenue grew, but management said that growth was constrained by indium phosphide laser supply. Communications bookings, by contrast, extend beyond a year. Investors should read that as visibility into demand, and Coherent is already seeing record-level bookings in optical networking products.
That is why export-license relief matters financially. If shipments normalize, Coherent would not need to prove demand from scratch; it could convert existing interest into recognized revenue. The company also said accelerating 1.6T transceivers are supporting adoption across hyperscale and DCI markets, which could help mix if supply constraints ease.
Bull case: easier exports could unlock booked demand
If permits loosen and capacity keeps expanding, including Coherent's six-inch indium phosphide capacity expansion, the company could turn constrained demand into stronger revenue and margin performance. The setup is attractive because the demand signal already appears visible rather than speculative.
Bear case: timing risk can still delay the payoff
The main risk is timing. Even with strong demand, prolonged permit delays can push revenue recognition further out. Management's Q2 2026 outlook of $1.56 billion to $1.7 billion in revenue and 38% to 40% non-GAAP gross margin points to upside, but it also shows the recovery still needs to happen. If scarcity persists, the mix benefit from higher-end optics may arrive later than investors expect.
AXT shows the pressure, but it is not a perfect read-through for Coherent
AXT offers the clearest public-market snapshot of how export controls can hit a business tied to indium phosphide. Its full-year revenue fell 11%, from $99.4m to $88.3m, and its fourth-quarter results missed guidance mainly because fewer-than-expected export control permits were issued after China introduced indium phosphide controls in February 2025.
That is the bear case in one snapshot: Beijing can turn a niche substrate into an immediate revenue problem. But it is not proof of a permanently closed valve. AXT was granted its first export permit for indium phosphide in late June 2025, and indium phosphide revenue recovered to $8 million in Q4 from $3.6 million in Q2, which looks more like rationing than a total shutdown.
There is also a limit to how far investors can generalize from AXT. The company manufactures all wafers in China, and 98% of its 2025 revenue came from outside North America. U.S. tariffs on its China-made wafer substrates reached 70% in 2025. That means AXT's pressure likely reflects a mix of export delays, tariffs, and geographic exposure rather than indium phosphide scarcity alone.
For Coherent, six-inch indium phosphide capacity expansion is a real offset, but delays in China's export licenses remain the live issue. The central debate is whether permit relief becomes more durable or whether China continues to exercise leverage through slower licensing.