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September 19, 2000

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JDS Uniphase

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Subject:  So you're thinking of buying SDLI
Author:  TylersDad

First let me apologize for the long post.

There's a lot talk on this board about the arbitrage play of buying SDLI instead of JDSU and coming out big dollars ahead because of the discounted spread between the SDLI and JDSU price figuring in the 3.8 share ratio. However, you better understand the dynamics before you buy.

For review here's how it works: JDSU is offering 3.8 shares for every share you own of SDLI. At the current closing price of $98 for JDSU, this means that SDLI should be priced at $98 * 3.8 = $372.4. Instead SDLI is priced at 302, a 23% discount from the $391 price. Or another way to look at it is if the merger were to complete today, you would have 3.8 shares of JDSU at the cost basis price of $302 / 3.8 = $79.5 for each share of SDLI. A nice gain.

The difference is discounted risk based on the confidence investors have that the merger will actually be approved. The more confident, the smaller the risk or discount.

Sounds like an absolute steal right? JDSU share for 79.5 bucks vs. $98.

It is under one condition. JDSU remains flat or goes up after you buy your SDLI. SDLI is absolutely married to JDSU at this point. If JDSU goes up, SDLI goes up and if it comes down it comes down at the ratio adjusted rate. For every dollar down of JDSU, SDLI comes down 3.8 dollars. Give or take a few percentage points based on the discount for risk.

Now, most of these "can't lose" scenario's are coming from people who claim to have done the very same thing with ETEK earlier in the year. My bet is that not everybody was happy with the way it worked out. Here's what happened with ETEK. Follow this link to the ETEK Chart.

The JDSU buying ETEK announcement came on 1/27/00. I immediately place an order for 100 at Market. It executed at 198 about $50 higher than the previous day close. This gave me a cost adjusted basis of JDSU at $90 based on the merger ratio of 2.2. (198/2.2) Notice the initial spike. A couple of days after the announcement, ETEK was priced below where you could have bought on the day of the announcement. It then proceeded to climb as high as 313. Now if this is where the story ends then it would have been a fabulous deal. Look at the chart. By mid April ETEK fell as far as 121. Being the loyal JDSU owner and Fool, I hung on firmly believing each day, it can't go any lower. ETEK cost adjusted shares were now at $121/2.2 = $55 which was about a 63% loss for me on paper.

Ultimately the deal closes on June 30. ETEK was at 265 and JDSU at 121 give or take a dollar. My cost adjusted $90 was now worth 121 a 34% gain on paper. Pretty good but very scary. Had I bought into this arbitrage at ETEK's peak I would have lost money. This arbitrage play was heavily discussed as a good way to get into JDSU through the entire ETEK deal. Had you taken the advice on the high side of ETEK you would still be regretting it.

3 months later JDSU is now 98 just 8% over my $90 cost adjusted shares from ETEK. So for all the risk, blood, sweat and tears was it worth it? You decide. . .

Good luck,


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