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July 12, 2000

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JDS Uniphase

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Subject:  Re: New Math?
Author:  stocksure

Henry, first of all, JDS didn't grow 40% sequentially last quarter. The actual number was around 23%, I think. 40% was after factoring in the OCLI acquisition. SDL, meanwhile, has forecasted at least 44% sequential growth. Part of this can be attributed to the PIRI acquisition, but that only closed on June 10. So most of that growth is organic. What's even more phenomenal about that number is the fact that last quarter, even though SDL grew their optical revenues by 163% annually, their overall revenue growth was a mere 92%. So not only are they seeing absolutely phenomenal sequential growth, they're doing it in spite of having some significant low-growth businesses.

SDL's operating margins are also rising at a very fast rate. They jumped from 22% to 30% in the last quarter, and are expected to see another large boost this quarter. An interesting fact about SDL is that although the company has 18% of the revenues JDS Uniphase has, it only has 10% of the employees, which means that assuming the company doesn't have some major non-employee-related expenses that constitute a much larger percentage of their revenues when compared to JDS Uniphase's, the margins it generates could be much higher.

JDSU already dominates the market for optical components. They have the largest stable of optical engineers around. I would have thought they would be least likely to pay whatever price for acquisition-related growth when they have such great potential to grow organically.

JDSU dominates a lot of optical components markets. They're the leading independent supplier of source lasers, EDFA systems, thin-film filters, Bragg Gratings, modulators, receivers, 1480 nm pump lasers, and a few other things as well. However, they're getting blown away by SDL in the high-end 980 nm pump (amplifier) laser market. SDL's 980 nm pump laser product, which constitutes the majority of its sales, is so much better than JDS Uniphase's that the latter actually buys the products of the former to use in its high-end amplifier (EDFA) modules.

Amplifiers modules currently constitute 40% of all optical component sales, and that number should rise in the following years, for two reasons:

1. Cable TV and metro DWDM networks. As we know, cable companies are rolling fiber deeper and deeper into their networks in order to offer internet access and other advanced services. The further you move fiber from a cable headend, the more amplifiers you're going to need to keep the optical signals sent from the headends strong. Meanwhile, DWDM is just beginning to be rolled out into metro networks. The annual growth here is absolutely unbelievable, and I'm sure it's well over 200%. As multiple beams of light get sent down these fibers for the first time, network operators will need to move from implementing amplifier systems that utilize only one laser to systems that make use of multiple lasers. The math isn't hard to do.

2. All-optical switching. Right now, there's only so much need for amplifiers to strengthen optical wavelengths on long-haul networks due to the fact that at every network junction, the wavelengths still have to be re-converted into electronic form. However, if the wavelengths are switched in the optical domain, then suddenly, in order to save the high costs related to tearing down wavelengths and setting up new ones, carriers will want to use systems that can send optical beams as far as it's humanly possible to do so before they have to be regenerated. These systems, such as the ones Corvis and QTera (Nortel) are offering, use a ton of amplifiers to get the job done.

One other thing, these long-distance transmission systems don't use EDFA-based amplification systems such as the ones JDS Uniphase dominates the market for. Rather, they use a relatively new technology known as Raman amplification. While JDS Uniphase is developing a Raman system, SDL's beaten them to the punch in this field by being first to market with a full-fledged Raman module. Unlike the EDFA arena, for which they only sells lasers for, SDL offers end-to-end systems for this market, and to the best of my knowledge, is currently the leading independent supplier in this field.

Last but not least, I found the following quote regarding the 980 nm market from an excellent LightWave article written a couple of months ago on the pump laser industry in general (found at http://lw.pennwellnet.com/home/archivearticles.cfm?Section=Archives&ARTICLE_ID=73469&VERSION_NUM=2&KEYWORD=SDL - free registration's required):

"The 1,480-nm market is a competitive market with numerous manufacturers," says Alcatel's Chretien. "On the contrary, the 980-nm market is not very competitive, with most of the market shared by SDL and JDS Uniphase."

Can anyone say monopolistic pricing power? Of course, for this reason, the DOJ might not be too thrilled about this deal. I guess we'll have to wait and see.

Still, if the deal does go through, it appears that the benefits JDS Uniphase derives from it more than justifies the price premium it's paying for SDL. Unlike the E-Tek merger, where capacity constraints were the primary driving force behind the deal, the synergies that can be found in this merger are absolutely tremendous.

Eric


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