COMMENTARY--JDS Uniphase is the undisputed heavyweight champion of the fiber-optic component market and could easily become a serious contender in the optical fiber sector if it weren't for the fact that its stock is performing like a 98-pound weakling.
But that's the way it goes for a company that, despite its unchallenged leadership position and vast potential, still finds itself at the mercy of both the flat-lining U.S. economy and the missteps of key telecommunications and network-equipment customers.
It doesn't help that roughly 75 percent of JDS Uniphase's sales are to North American customers such as Nortel Networks (NYSE: NT) and Lucent Technologies (NYSE: LU), companies that are reeling from an economic malaise that's particularly acute in this neck of the woods.
JDS Uniphase owes a lot of its success to an aggressive acquisition strategy that culminated with its $17 billion puchase of SDL, the world's second-largest components vendor, in February.
Now that Lucent has confirmed its long-rumored intentions to sell its fiber-optic cable unit, JDS Uniphase--as likely a buyer as any--is hamstrung not only by softer-than-expected sales and earnings but the fact that it's lost more than $108 billion in market capitalization since closing at $135.94 a share on July 26.
Lucent doesn't really want to sell this business but it doesn't have much of a choice.
It's cash strapped and has more than $5 billion in debt maturing at year's end, according to its January filing with the Securities and Exchange Commission. That's what happens when you post a $1 billion operating loss like it did in its most recent quarter while simultaneously announcing you will cut loose more than 10,000 workers.
Along with JDS Uniphase, Corning (NYSE: GLW), the leader in this space with about 50 percent of market share, Alcatel (NYSE: ALA) and any number of Japanese vendors including Furukawa Electric, Sumitomo Electric, Hitachi Cable and Fujikura are considered possible suitors for the fiber-optic cable unit.
Analysts guesstimate it could sell for between $4 billion and $8 billion. Lucent's hoping it can get something closer to $10 billion.
But considering the current economic climate and the dearth of potential buyers with any significant cash laying around, it's likely Lucent would only get between $4 billion and $6 billion, assuming it finds a company interested in making that commitment.
JDS Uniphase doesn't do fiber cable so there's no reason a deal couldn't be consummated, at least from a regulatory perspective. It makes equipment such as source lasers and components that modify and switch signals, and modules that amplify and transmit signals through the fiber.
It's not too much of a stretch to think the company would like to become something of a one-stop shop for all things fiber, giving it a closer relationship with the service provider's end users and, thus, a better way to gauge demand for its components.
As this recent inventory glut has illustrated, that knowledge would be extremely useful to JDS Uniphase.
Lucent's fiber-optic business is already turning a profit so there's a good chance it would immediately add to JDS Uniphase's bottom line, no small consideration in these dreary economic conditions.
UBS Warburg analyst Joseph Wolf wrote in a March 2 research note, "Financially, if we assume that Lucent's fiber business was about $2 billion in calendar 2000 and, assuming a conservative growth rate of between 15 percent and 20 percent and (net profit margins) of between 10 percent and 15 percent, we believe that in a $4 billion to $7 billion range, the deal would could be neutral to marginally accretive to (JDS Uniphase's) calendar 2001 earnings."
In theory, JDS Uniphase would be a logical suitor but, according to Wolf, shareholders aren't too excited about the prospects of branching out into the fiber business in these uncertain times.
"I could paint both pictures," Wolf said Wednesday. "There are certainly some reasons for JDS Uniphase to acquire the business, especially for strategic purposes. But you have to balance that with shareholder reaction. There's a sizeable contingent of JDSU shareholders who wouldn't mind if the company took a breather from acquisition for a while."
There's also the cash issue.
"Given our opinion that any deal would need to be cash and that JDS Uniphase now has $1.1 billion on its balance sheet, the deal might prove challenging in these volatile market conditions," Wolf said.
Had this opportunity been available to JDS Uniphase a year or even eight months ago, the company might have jumped at the chance and never looked back.
Then again, if the market and the economy hadn't collapsed in this same period, Lucent would be more inclined to hold on to the business.
Investors looking for a stock they can hold for the long haul would be hard-pressed to find a better choice than JDS Uniphase below $23 a share whether it takes a gamble on the fiber-cable unit or stands pat with its impressive components arsenal.
"There's no true catalysts right now for the stock and there's a lot of negative sentiment," said Jim Jungjohann, an analyst at CIBC World Markets. "And there's still a ton of capacity out there. But for patient investors, it's a good value right now."
The same could be said for Lucent's cable-fiber business, especially for a company like JDS Uniphase that will eventually need to expand its product line to generate the kind of sales growth that justifies the multiples it was trading at not too long ago.