Investors in complex technologies often look beyond the service providers -- whether wireless communications or Internet dial up or broadband -- to the companies that supply the infrastructure. At the height of the boom in 1999-2000, the Three Kings of Infrastructure were Cisco Systems (NASDAQ:CSCO), Qualcomm (NASDAQ:QCOM), and -- this column's focus, JDS Uniphase (NASDAQ:JDSU).
The infrastructure argument? Forget trying to pick the Web winners, just buy the company making all those routers -- Cisco Systems. No need to guess when or where 3G wireless communications will arrive, just bet on Qualcomm, whose technology will power an ever-growing share of it (for more on this fascinating company, read Bill Mann's latest).
And in the world of unlimited bandwidth supporting high-speed Internet and data traffic, the nearly instantaneous transmission of data 'round the world? Many little companies offered hot technologies, but there was one dominating infrastructure monster.
Bandwidth, baby
Dozens of companies like Level 3 Communications (NASDAQ:LVLT) and Global Crossing joined traditional voice carriers in the race to build long-haul fiber-optic networks to speed data transmission for hungry businesses and consumers. But as these companies loaded up with debt and offloaded pay on their executives, investors looked to JDS Uniphase as the infrastructure play.
Formed by the June 30, 1999 merger of Bay Area Uniphase and Canada's JDS Fitel, JDS Uniphase would be the dense-wave division-multiplexing messiah of the telecosm, selling the equipment to provide unlimited bandwidth and unleash untold innovations and riches.
Dangerous visions
JDS Uniphase didn't stand alone among innovators in optical networking components and systems, but it had the story and the hype. No one touted the company more publicly than futurist George Gilder, whose book Telecosm and newsletter TheGilder Technology Report captivated readers with the story. I was one of those who fell under his spell: What writer wouldn't love a book which spouts hoary, paladin, boffins, gaggles, stentorian, regnant, ursine and industrial demiurge without taking a breath? (Today, I much prefer our own Motley Fool Stock Advisor. Great stocks -- and great prose.)
The stock ran away with the moon, exploding into well over a ten bagger from March 1999 to March 2000. The company used these inflated shares to gobble up competitors and complementary businesses, absorbing E-Tek Dynamics, Optical Coating Laboratory, SDL, and IBM's optical transceiver business, among many, to become the leading supplier of components and subsystems to telecoms.
But when limitless supply met dwindling demand, the infrastructure companies were no haven. Revenues collapsed from $3.2 billion in the year ending June 2001 to $676 million in the most-recent trailing 12 months. So did the stock -- collapse, that is. Check the 5-year chart vs. the S&P 500 to see its decline from a Mar. 6, 2000 split-adjusted close of $146.35 to yesterday's $2.91.
Gilder plus five
That was then, and this is now. When others avert their eyes, astute and definitely risk-tolerant investors may revisit the battered symbols of the boom era for opportunities -- as I recently did with Lucent (NYSE:LU). But might not such informed speculators be hanging on to the losers of the past at the cost of missing out on today's innovators, such as those featured in Jeff Fischer's ongoing series on recent IPOs? It's an important question.
On one side is the sage advice of Warren Buffett, among others, that advances in technology bring few profits to their peddlers but great benefits to consumers. On the other side are the words of a friend of Gilder's quoted last year in Wired. He said he simply added five years to Gilder's futurist divinations, which would put the telecosm somewhere in 2004-2005. All the while, wireless and broadband have been quietly proliferating.
One thing is clear, survival depends in large part on cash. JDS Uniphase said last Thursday that it had $1.23 billion at the end of its fiscal year June 30. With no debt.
Cash = survival
Two years ago, I examined the ability of optical networking companies to survive the draught in Weathering the Optical Equipment Storm. Like JDS Uniphase, almost all were in the catbird seat -- debt free. So it was easy to look at trailing-12-month cash burn and compare it to cash and equivalents to provide a rough guess of how many years they could survive -- assuming that capital markets would not be inclined to throw more money at them.
This assumed consistent revenues, expenses and burn rates. They have been anything but. Looking at JDS Uniphase specifically, we see that revenues have stabilized but burn -- using the very rough measure of net cash from operations minus capital expenditures -- remains significant:
Cash & Cash
Quarter Revs. Equiv. Burn*6/03 $161 mil. $1234 mil. N/A 3/03 167 1266 $(73)12/02 157 1331 (59)9/02 193 1357 (75)6/02 221 1450 173/02 264 1565 (52)12/01 287 1653 (36)9/01 327 1754 12
*Net cash from operations - capital
expenditures.
When the company files its next 10-K, it will be important to note whether cash burn declined in the last quarter. But even assuming the company continued to burn cash the last three quarters at an annualized rate of around $267 million, the company could survive between four and five years without recourse to the capital markets.
Survival yes, but...
Can revenues recover sufficiently to generate adequate free cash flow and rewards for investors? Here are two points to consider. First, just about everything I've read overlooks the fact that the company's business shows two very different faces -- communications (optical networking components and subsystems) and thin film (optical coatings for everything from photocopiers to medical instruments to defense systems).
While the sexy, telecosmic communications business segment has collapsed and subsequently stabilized, the lower-margin, decidedly boring thin film business has turned in eight very decent quarters, despite the most recent flat one. Indeed, for the last three quarters, thin films have exceeded communications revenues by anywhere from 10% to 28%. With my decidedly non-expert knowledge of the business, I'd opine that thin films could show at least a cyclical upturn well before -- if ever -- the communications business recovers.
The second point is that improving gross margins imply that some of the company's cost-cutting efforts have been reflected in lower cost of goods sold, though operating expenses are still high enough that the income statement shows a hefty net loss:
Thin Gross
Quarter Comm. %YOY* Film %YOY Margin6/03 $76 mil.(44%) $85 mil.(1%) 24%3/03 74 (60%) 94 20% 15%12/02 75 (66%) 82 26% (4%)9/02 109 (57%) 84 18% 4%6/02 135 -- 86 -- (14%)3/02 186 -- 78 -- 9%12/01 222 -- 65 -- (17%)9/01 256 -- 71 -- (5%)
*Year-over-year, or current period versus
same period the year before
The bottom line
For me, it's too early to buy JDS Uniphase, even for the speculative part of my portfolio. To make the risk-reward equation more favorable, I'd like to see the thin film business grow, communications recover, gross margins continue to improve, and operating expenses decline. Yup, just a few little things like that. But guess what? While I wait for that, there is still blood in the optical networking streets, and one thing seems more than likely: If and when the blood is cleaned up, today's prices will be long gone. So we'll be watching this one closely -- especially the thin films segment.
Your mileage may vary, but you can definitely increase your fuel economy by visiting our active JDS Uniphase discussion board. -- just read RtVandelay's recent thoughtful comments for a prime example.
Have a most Foolish week, and thanks for reading!
Writer and senior analyst Tom Jacobs (TMF Tom9) saw one very thin film this weekend, Johnny English, and loved it. He welcomes your comments at[email protected]. For individual financial advice, enjoy your freeTMF Money Advisortrial today! Tom owns no shares of companies mentioned in this column, but he does own others you can find inhisprofile. The Motley Fool isinvestors writing for investors.
