Motley Fool Staff
Jan 5, 2000 at 12:00AM
What I'd like to do in this report is talk a little bit more about what the company does and why it's been so successful. In future reports, I'll follow up by taking the company through the 10 Rule Maker essential criteria and will also include a Rule Maker Ranker spreadsheet on the company.
JDSU is certainly a high flyer. If you judge the company using such metrics as its P/E ratio, then you'll likely dismiss the stock as just another overvalued high technology company. However, there's really a lot more to the story than a lofty current valuation. When I study a company, the most important factor I look for is a quality management team. I like to ask myself questions such as: Does management have a long-term vision and strategy? Does it have management of unquestionable integrity? Does the management team have depth or is it merely led by one person?
These are questions that Philip Fisher, the author of my favorite book on investing, Common Stocks and Uncommon Profits, investigates on any stock that he studies. (If you're interested in discussing more about Fisher style investing, we discuss it on the Grape's Fisher Kings message board.)
Noted technology futurist George Gilder penned a recent article that makes a strong case for JDSU having a visionary management team. In this article, The Intel of the Telecosm, Gilder talks about how Uniphase's CEO, Kevin Kalkhoven (Note: This article was written before Uniphase's merger earlier this year with the Canadian company JDS Fitel), was essentially able to see the heavy demand for additional bandwidth well before it happened. At the time of these acquisitions, Uniphase was generating about $30 million of revenues by selling helium neon lasers for portable bar code readers. Due to differences in the type of signal emitted, these lasers were the exact opposite of those that JDSU is so successful at selling today.
Kalkhoven's vision led Uniphase to make three key acquisitions. The first took place in 1994 when Uniphase moved aggressively to acquire United Technologies' photonics research division. This move was followed by the acquisitions of IBM's laser operation in 1997 and the Philips optoelectronics group in 1998. Interestingly enough, each of these acquired operating divisions were and would have been profitable in their own right, but were essentially abandoned by their former owners in the interest of pursuing other businesses. Kalkhoven had the vision to see that these three acquisitions provided Uniphase with the essential technology that would allow it to become the leading provider of optical components for the Wave Division Multiplexing (WDM) market.
I also admire Kalkhoven's desire to finance his company's growth the old fashioned way, that is through the internal generation of good profits. He also seems to be fond of the fact that the company has no debt and plenty of cash in the bank. These attributes are near and dear to the heart of Rule Maker investors.
When it comes to depth of management, Kalkhoven is not a one-man show. Chief Operating Officer Jozef Straus, a former Nortel executive, is in charge of the company's manufacturing operations. Straus decided to stick around after the JDS Fitel merger. He and Kalkhoven share responsibility for setting the firm's priorities, and have a good working relationship. Both of JDSU's leaders seem more than willing to openly communicate about the company with investors, which I believe is a sign of their integrity as well.
One other characteristic that Fisher considers important to technology companies is having engineering leadership rather than just a lot of patents. While JDSU does have a number of patents, it's even more important to note its engineering expertise. The company employs a high number of physicists/photonic engineers. As you can probably guess, these kinds of people don't grow on trees. It would be difficult for any potential competitor to put together a group of qualified people that are as strong as the group that has been assembled by JDSU. Additionally, there are very few suppliers for most of the equipment needed to manufacture pump laser chips. Therefore, any new competitors would have to design and build their own machines as well as the products. The end result is that JDSU's competitors face high barriers to entry.
The bottom line here is that I think JDSU has a strong management team and a gorilla competitive position in the marketplace. Next, let's talk a little bit more about what JDSU does and then combine that with what we've talked about above to get an idea of how it fits together into a business model.
In essence, fiber optic technology is not that complicated. It involves sending photons down glass instead of sending electrons over copper wire. The advantage of transporting light rather than electrons is that it can be split into many colors (think of the way a prism splits light into a rainbow). As a result, more information can move through a fiber optic wire than through a copper wire. Presently, a fiber optic cable can transmit up to 96 different colors of light. Once the fiber optic cable is in the ground, JDSU sells products that allow the light that moves through the cable to be differentiated into more and more streams or pathways, so more information can pass through it without laying additional cable. JDSU's lasers boost the optical signals that pass through these cables. Every long stretch of fiber, particularly those that lie on the bottom of the ocean, needs these lasers by the thousands.
According to this recent interview with Kalkhoven, fiber optics is similar to "a little flashlight -- in this case a laser -- that you switch on and off creating dots and dashes of light that go down a piece of fiber and can be detected at the other end. It's simply nothing more than a high-speed telegraph. But instead of sending Morse code electronically, [JDSU does] the same kind of thing using light."
On one hand, I don't understand all the specifics of what JDSU does, as its area of technical expertise is outside my own. But, I do understand enough of what the company does (from my pre-med days) so that I'm fascinated by JDSU's technology and the potential benefits that may be realized if it successfully executes its strategy. I also know that I crave additional PC bandwidth, and I like the idea of investing in companies that have a key role in providing it.
Finally, let's look at JDSU's business model and compare it to some of our other Rule Makers, as I feel that this may provide some insight into the company's ability to succeed in the future. In some ways, I see JDSU as a combination of two of our other technology holdings: Intel (Nasdaq: INTC) and Cisco Systems (Nasdaq: CSCO). Intel's dynamic growth started when it moved from manufacturing memory chips to manufacturing the key components found in personal computers. Similarly, JDSU's business model is directed towards enabling it to become the leading supplier of optical components.
Like Cisco and its range of Internet infrastructure equipment, JDSU aims to be an end-to-end supplier of optical components. This strategy was further exemplified by Uniphase's merger in mid-1999 with JDS Fitel, a supplier of passive components for optical networks (Uniphase makes active components). Essentially, JDSU has positioned itself as the primary supplier of components that light up, run, maintain, and control the advanced fiber optic systems of the future. One big difference between Cisco and JDSU is that JDSU sells its products to equipment manufacturers while Cisco's products are sold to end-users.
As a matter of fact, I recently read that The Gorilla Game author Geoffrey Moore believes that JDSU is a possible young gorilla in the making, which is a title currently bestowed upon Microsoft (Nasdaq: MSFT), Intel, Cisco, Oracle (Nasdaq: ORCL), and SAP (NYSE: SAP). With $1 billion in sales, JDSU is such a large player in its industry that it is bigger by 50 percent than the rest of the independent component makers -- COMBINED!
From the numbers side, JDSU is unfortunately a bit difficult to sort out. The combination with JDS Fitel has made the financial statements somewhat awkward. We'll work our way through those numbers as well as the rest of the Rule Maker essentials next week.
A couple of final notes...
Today we sold the entirety of our Foolish Four holdings, as we said we would on Monday. You can review all of our trades on our RM Trade History page.
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Have a Foolish week.
Phil Weiss (TMFGrape on the boards)
Motley Fool Staff
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