JDS Uniphase/SDL Merger Approved

After months of waiting, the Department of Justice gave antitrust clearance for fiber-optic components maker JDS Uniphase to purchase competitor SDL, after JDS Uniphase agreed to sell its Swiss plant to Nortel Networks for $3 billion. The deal, JDS Uniphase's ninth since its 1999 formation, further cements the company's lead as the components maker with the most products and broadest range. Despite the good news, investors hold wildly divergent views on how the shares should be valued.

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By Tom Jacobs (TMF Tom9)
February 6, 2001

No more delays for the biggest fiber optic merger to date: The Justice Department (DOJ) has finally approved the marriage between fiber-optic components maker JDS Uniphase (Nasdaq: JDSU) and competitor SDL Inc. (Nasdaq: SDLI). JDS Uniphase will pay 3.8 shares of its shares for each share of SDL. Though SDL was worth $41 billion when the merger was announced July 10, JDS' stock decline shaved that to a current $17.6 billion. Both merger partners' stock jumped on the news in trading this morning.

Antitrust concerns
The DOJ's antitrust antennae tuned in to possible JDS Uniphase dominance in the market for lasers that amplify signals in fiber optic networks -- glass fiber high-speed telecommunications networks necessary for the insatiable data transfer appetite of the Internet age. JDS Uniphase and SDL compete in at least six of twelve key fiber-optic component markets: external modulators, laser diodes, laser subsystems, Raman lasers, and source lasers or pump lasers for telecom. (This is not Sanskrit. Chris Rugaber clearly explained the industry in "All About Fiber Optics" -- and eschews jargon. Mostly.).   

To satisfy the government, JDSU announced last month that it would sell a Swiss plant to Nortel Networks (NYSE: NT) for $3 billion -- $2.5 billion in Nortel stock and up to $500,000 in future payments for Nortel purchase of JDSU components. Nortel is the number one fiber-optic systems vendor and number-two JDS Uniphase customer. This quieted the DOJ's anxieties. To sit in the government's shoes, check out our Foolish roundtable overview of the optical networking industry.              

How JDS Uniphase grew
JDS Uniphase first burst through as a fiber-optic components powerhouse when California's Uniphase announced the proposed purchase of Canadian JDS Fitel Inc. in January 1999. After the deal closed that June, the new JDS Uniphase used its stock to go on a debt-free shopping spree, buying competitors including Optical Coating Laboratory Inc. and E-Tek Dynamics and chasing a market estimated to grow from $5 billion in 2000 sales to $24 billion in 2004. JDS Uniphase's acquisition strategy -- nine purchases so far -- has helped order a fragmented business and make the company a one-stop shop for all a customer's fiber needs.

Futurist George Gilder, among others, fingered the company as the player best poised to lead the tectonic shift in high-speed transmission of unlimited data -- the bandwidth revolution. (For more thinking on this business, check out our Telecom & Networking InDepth area.)

The company faces some risks...
JDS Uniphase faces risks as it moves to dominate the fiber-optic components business. In keeping with management's stated goal to double manufacturing capacity every 18 months, the company must maintain quality. It must also succeed in integrating its many new businesses, often the downfall of fast growing, acquisitive operations. And demand will not stay red-hot forever. Woes at top customer Lucent (NYSE: LU) and a slowing in telecom network upgrade spending led JDS Uniphase to lower growth forecasts to 7-10% for each of the next two quarters. 

...but is building a moat
JDS Uniphase must also innovate in the face of huge capital flowing to new fiber optic technologies, but it's well positioned. The company offers a large of stable of scarce specialists -- engineers with expertise in dense wave division multiplexing -- whose products calm anxious systems integrators and vendors: Why risk  products from diverse upstarts when you can go with what's proved to work from one place? Some industry observers, such as Epoch Partners' Mark Langley and John Harmon, believe that the one-roof and acquisition strategy cements JDS Uniphase's sustainable competitive advantage: It can drive down costs better than any competitor and offer such a broad range that customers design their systems based on JDS Uniphase components. Better yet, JDS Uniphase is also moving downstream to product integration itself.

JDS stock: steal or too costly?
JDS Uniphase: A company sitting in the catbird seat, but a good investment at current or projected valuations? Investors are debating furiously. Richard McCaffery explains his view of JDS' valuation as published in The Motley Fool's Industry Focus 2001, along with other Fools, notably in this fantastic discussion board thread.

The company's stock closed yesterday at $50, within a 52-week range of $37 and $153.41, while SDL closed at $185.63, 77% above its 52-week low of $117.63 and off its high of $460.50. While both rose in this morning's trading, Nortel is flat this morning, after closing yesterday at $35.75, within its 52-week range of $29 and $86.  

Tom Jacobs (TMF Tom9) lives in Old Town, Alexandria, not far from Fool HQ, so he won't get lost on his way to work. At press time, he owned shares of JDS Uniphase. To see his stock holdings, view his profile, and check out The Motley Fool's  disclosure policy.

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