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JDS Uniphase atop the optical peak as merger close nears

The company's acquisition of SDL is expected to create an optical parts powerhouse at a time when fiber-optic systems and networks are beginning to bloom.

    JDS Uniphase is poised to dominate the optical components market like never before, but looming economic clouds stand to shake that industry's foundation.

    The maker of hardware for communications networks has used its size and extensive product line to dominate its business and dwarf the competition.

    Now, having gained Justice Department approval Tuesday, JDS is close to completing its acquisition of SDL, a components competitor that stands to bolster JDS's position even further. The deal is expected to create an optical parts powerhouse at a time when fiber-optic systems and networks are beginning to bloom.

    "The merger gives them the benefit of size," said Mark Langley, a senior analyst at Epoch Partners, an investment bank. "I'd argue that JDS was already an 800-pound gorilla before the merger. Now the merger makes JDS a bigger, stronger, more impressive gorilla."

    The merged behemoth will not find itself without challenges, however.

    Chief among them is the projected decline in spending by telecom companies. The company and the entire industry could stumble if telecom carriers do not continue spending to build their networks. Already many communications carriers have trimmed their spending on hardware in light of the slowing economy and lower revenues.

    The spending slide means telecom companies will order less equipment from equipment makers, which will then purchase fewer components from JDS. Stock in JDS, and many other optical and networking companies, has slipped accordingly in the past few months.

    Then there are other problems. JDS mentioned in its most recent earnings conference call that its customers are working on reducing excess inventory that was stockpiled when components were in short supply.

    As with any major merger, JDS faces the task of integrating SDL successfully, without losing its focus on selling equipment and developing new technologies.

    Analysts say established equipment giants, including Lucent Technologies, Nortel Networks and even Intel, pose some competitive threats to the newly combined company. Analysts also say several of the industry's smaller upstarts could collaborate or consolidate to challenge the sector's leaders.

    "It's not just a case of JDS and SDL walking down the aisle and making off with the optical components business," said Maribel Dolinov, a senior analyst at Forrester Research, a market research firm.

    A stronger position
    The deal is primarily intended to broaden JDS's product line, complementing its core components business. Analysts say the broader product portfolio will give the combined company more insight into trends in the carriers' networks, allowing them to tailor future products to the industry's needs.

    "(JDS) gets to see everything that goes on in technology," said Mark Langley, a senior research analyst at Epoch Partners, an investment bank. "They have more exposure to more people up and down the food chain," Langley said. "They gain a better understanding of products and market shifts."

    JDS is not shy about gobbling up companies that add to its portfolio or pose a competitive threat. The SDL deal is only the latest example.

    In a little more than a year, JDS closed the acquisitions of E-Tek Dynamics, Cronos Integrated Microsystems and Optical Coating Laboratory and announced its merger with SDL just 10 days after closing its $15 billion union with E-Tek.

    JDS' high share price compliments this strategy since it makes most of its acquisitions with stock. The shares have traded as high as $153.42 over the past 52 weeks.

    Surviving the telecom downturn
    A recent study by the Dell'Oro Group indicates that, despite the current telecom downturn, the demand for faster Internet networks will cause the worldwide optical transport market to double by 2005 to $57.3 billion from $23.5 billion in 2000.

    Despite this, a see story: Telecom players spend big, but win littlecurrent inventory backlog has equipment makers buying less from JDS, and when combined with the lower demand from telecom companies, could translate into an even bigger slowdown.

    As a result, JDS forecast that revenue for its fiscal third quarter will grow just 7 percent to 10 percent, slightly below analysts' expectations. The company still believes it will make its target of 115 percent to 120 percent revenue growth for the fiscal year from the previous year, but cautioned investors that it could hit the low end of that range.

    JDS is not alone in predicting a slowdown. "All the optical companies that reported, with the exception of New Focus, reported flat guidance" for at least the next quarter, said George Hunt, senior vice president of Wachovia Securities.

    Most analysts think the slowdown will last just a couple of quarters then pick up in the second half of the year, and JDS seems wildly optimistic that the spending boom will continue.

    Chief Financial Officer Anthony Muller reminded investors during the most recent earnings conference call that the information economy will flicker if carriers do not keep up with the demand for network capacity.

    "If carriers don't invest in adding capacity and adding bandwidth, the whole Internet's going to look like the California electrical market," he said.

    Some analysts believe that telecom companies will still spend, even in a slowdown. Many believe optical spending is the last thing a carrier will cut in lean times. "Unless carriers have to watch every dollar they spend, they are going to spend it on optics," Hunt said.