Smith Barney JDSU VISIT--REITERATING BUY RATING AND $300 TARGET
JDS Uniphase Corp(JDSU)*
Rating: 1H
Salomon Smith Barney ~ January 31, 2000
01/31/00 JDS Uniphase (JDSU $195.87,1-H,Tgt $300.00) Lissa Bogaty
--SUMMARY:--JDS Uniphase--Connectors & Other Components
*Visit to JDSU--Strongly Reiterating Buy Rating and $300 Price Target.
*JDS Uniphase is in a unique position, one of the most significant enablers
of the optical revolution.
*Rapidly evolving product landscape and well-stocked tool kit are enormous
barriers to entry.
*Customer-driven market reduces technology risk
*Fundamentals, anticipated upward revisions in estimates, stock price that
allows most aggressive acquisition pace all reasons to own JDSU.
01/31/00 JDS Uniphase (JDSU $195.87,1-H,Tgt $300.00) Lissa Bogaty
--EARNINGS PER SHARE--------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 06/99 EPS $0.07A $0.08A $0.10A $0.12A $0.37A
Previous 06/00 EPS $0.14A $0.18A $0.20E $0.22E $0.74E
Current 06/00 EPS $0.14A $0.18A $0.20E $0.22E $0.74E
Previous 06/01 EPS $0.24E $0.26E $0.28E $0.31E $1.10E
Current 06/01 EPS $0.24E $0.26E $0.28E $0.31E $1.10E
Previous 06/02 EPS $N/A $N/A $N/A $N/A $N/A
Current 06/02 EPS $N/A $N/A $N/A $N/A $N/A
Footnotes:
01/31/00 JDS Uniphase (JDSU $195.87,1-H,Tgt $300.00) Lissa Bogaty
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1H Prior:No Change Price (01/28/00)....:$195.87
P/E Ratio 06/00.....:264.7x Target Price..:$300.00 Prior:No Change
P/E Ratio 06/01.....:178.1x Proj.5yr EPS Grth...:50.0%
Return on Eqty 99...:N/A% Book Value/Shr(99)..:23.87
LT Debt-to-Capital(a)0% Dividend............:$N/A
Revenue (00)........:1134.10mil Yield...............:N/A%
Shares Outstanding..:179.5mil Convertible.........:No
Mkt. Capitalization.:35158.7mil Hedge Clause(s).....:
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
01/31/00 JDS Uniphase (JDSU $195.87,1-H,Tgt $300.00)
--OPINION:------------------------------------------------------------------
UNRIVALED FUNDAMENTALS, BUY JDSU
We recently returned from a field trip to JDS Uniphase's large Ottawa
facility, and we are not simply reporting on the visit but trying to
sound a louder, higher-pitched siren to alert investors of the unrivaled
attractiveness of the fundamentals. While these are already much
appreciated (hence P/E on calendar 2000 of 212), visits like ours on
Friday help clarify and focus the vast panorama of the optical components
industry into a high-resolution snapshot that offers a new level of
clarity and understanding that we believe can help drive investment
decisions.
STAR-STUDDED LINE UP OF IMPRESSIVE TALENT...
Hearing from people actually involved in product development and who
regularly talk to customers, in our view, adds substance to the rather
conceptual messages we consistently hear from management. Our visit
included presentations and discussions with some of the leading
executives and scientists in the company and the Fiber Optic Components
group, including a tour led by extremely knowledgeable and articulate
operations experts.
...EXPLAINING MORE THAN TECHNOLOGY, BUT BRINGING TO LIGHT STRONG
FUNDAMENTALS, DRIVEN BY CUSTOMERS
It would be hard to match these fundamentals: although every
presentation began with the original mover, Internet growth, this
powerful driver dwindles to a weak signal light years away in the vague
beginnings of the universe when we consider the chain reaction of
fundamentals it unleashes. It's not just about growth of data traffic:
it's about the impact this is having by creating urgent customer needs in
a rapidly evolving product landscape that has put JDS Uniphase in an
unique position because of the assets it can bring to bear to meet these
needs, perhaps unparalleled in the history of components technology. In
fact, we believe that it is extremely rare for customers to drive a
market to this extent, in some sense bearing the costs of a complex
selling and R&D organization and reducing the technology risks
substantially, in our opinion.
At its recent investor meeting, Level 3 invited suppliers to exhibit in
the same auditorium in which management presented to investors. In
general, when you have a situation in which major carriers are using
technology as a strategic tool in competing and are bragging about their
ability to get delivery of equipment and touting their mind share with
the equipment start ups, the shoe is on the other foot, and while prices
for equipment and components will be driven down by the strongest
companies with the biggest cost advantages, given the relatively small
set of large customers, this price competition only serves to raise the
barriers to entry, in our view. In other words, we have in the optical
systems and components markets a situation in which equipment vendors are
enabling their customers to a degree perhaps never witnessed. They are
enabling them to establish time-to-market advantages in meeting the needs
of the proliferating and rapidly growing customers, who are themselves
adding customers and applications to the Internet at a dizzying pace. In
our mind, all of this justifies the sky-high multiples the optical
equipment and components stocks are commanding.
CUSTOMERS AND APPLICATIONS MOVING AT A FAST PACE ARE DRIVING TODAY'S
MARKET MORE THAN TECHNOLOGY
Our visit to Ottawa was meant to help the attendees understand the
technology. But ironically, we came away realizing that the technology
is almost peripheral (a bit of an exaggeration), but it is the
applications that are the drivers; customers are offering the
opportunities; and JDS Uniphase's approach to innovating around these
opportunities with an entrepreneurial culture suits today's market
requirements.
WE BELIEVE JDS UNIPHASE IS IN A UNIQUE POSITION TO MEET CUSTOMER
REQUIREMENTS
JDS Uniphase's skill set in mass customization is an enormous asset in a
market in which few standards have been set as technology moves faster
than anyone imagined, and management referred to the "re-calibrating" of
the industry to this faster reality. The requirements of customers to
construct solutions quickly that can be modified in the field plays to a
set of strengths unequaled by others, throwing up huge barriers to
entry. JDS Uniphase's unique set of skills include:
* experience and scale in mass customization
* biggest and broadest tool kit of products
* entrepreneurial culture spread by lots of feet on the street who can
fan out and take specifications back to the lab
* head start with start ups (redundancy in sales force during JDS/UNPH
merger allowed the combined company to continue to serve large customers
while establishing early relationships with new optical systems
companies)
* scale advantage in capacity additions and throughput improvements
BARRIERS TO ENTRY GETTING MORE FORMIDABLE
Management's strategy (Phases I-III) is more than bullet points on a
slide show, but nothing short of visionary, not to mention well timed.
This strategy has thrown up formidable barriers to entry:
1. broad tool kit of technologies and products both internally developed
and acquired offers unequaled ability to work with customers on design
challenges, not just a smorgasbord that creates ability to drive nebulous
"selling synergies", but crucial ingredients for delicate, fine-tuned,
custom systems that need to be optimized quickly and modified on the fly
2. capacity to supply customers offered by scale makes them the first
phone call when customers are in need (similar to Corning's situation in
fiber--and think about the impact on keeping your selling expenses low)
3. opportunities to develop integrated and hybrid devices utilizing all
the products is becoming more tangible as applications arise at a
faster-than-expected pace
RAPID PRODUCT EVOLUTION FAVORS A BIG COMPANY WITH BROAD RESOURCES
The pace of change was mentioned over and over again as a day-to-day
reality that the product people experience. No one would have thought
when Uniphase's most critical challenge was putting more resources behind
increasing the power of its 980 chip development effort that the
opportunity would be this big and break its way so well and in so many
different directions. Now, though we worry that the company may
occasionally lag in a product line or two against competitors, the big
picture--a rapidly moving kaleidoscope--becomes more important than any
individual products, in our view.
We view the breadth of the product line built over the last year or so to
be perhaps JDS Uniphase's most valuable asset. JDS Uniphase's extensive
tool kit at this stage in the development of the industry, when customers
have to patch it all together quickly, is a unique capability and
significant positive for the company. The idea of one-stop shopping was
really driven home by during our visit. This is not just a theme, it's a
significant reality. The ability to have the solutions to work with
customers tends to snowball into larger opportunities with customers as
you enter early in the design process and spend a lot of time with the
design teams of your customers. Time to market has emerged as such a
critical factor for success, that equipment OEMs are working with JDS
Uniphase on a daily basis to tweak specs as they rush to introduce, ship,
and install products. Furthermore, these close working relationships
with customers help get your people organized and lower the entire cost
structure of the enterprise by eliminated many selling efforts and
increasing the productivity of salespeople, sales engineers, and research
engineers.
SCALE IS AN ADVANTAGE IN INCREASING CAPACITY, PARTICULARLY AS NUMBER OF
WAVELENGTHS INCREASES
Scale is clearly an advantage when it comes to increasing capacity, which
requires the resources to invest heavily, mind share with capital
equipment providers, experience to drive process improvements, and,
perhaps most importantly, a large product set and high revenues to spread
the costs of automating across.
The expansion in the number of wavelengths has added to the challenges
faced by optical components suppliers and increases the need for scale.
To have the ability to supply up to 160 wavelengths in the near future,
larger companies with lots of revenue per wavelength should be able to
justify the expense of producing these wavelengths in parallel, versus
serially, which is resulting in cycle times that are currently
unacceptable. This wavelength issue applies to filters, lasers, and
OADMs and other switching products and reverberates throughout the entire
product line as designs for products like amps and monitors. Just as
competitors are trying to enter the market, the rapid development of the
systems they supply should leaves them in a perpetual state of catch-up.
It appears that capital equipment providers are seriously backlogged in
this atmosphere.
THROUGHPUT AND AUTOMATION OPPORTUNITIES
In Ottawa, the company is in the process of filling in a doubling of
floor space while constructing an addition that should nearly double it
again. But capacity can be expanded even more significantly by
throughput improvements resulting from process re-engineering and
automation, which the company is now analyzing. We met an extremely
impressive group of people who have created what looks like a very hard
to duplicate manufacturing environment clearly bursting at the seams and
continually adding capacity without taking down the whole system. They
have met and continue to innovate around the challenges of training,
materials flow, testing, process engineering, outsourcing, coordination
with internal and external suppliers, as well as capital equipment
vendors, etc.
The tour brought home the advantages of scale in terms of collective
experience of employees. We got the impression that making many of these
products requires time-consuming blocking and tackling that experience
can help avoid, and making these products in volume is even more of a
challenge.
WDM MESSAGE: FILTERS OFFER THE FLEXIBILITY THE MARKET NEEDS
The presentation on WDM technology sent a number of messages. For us,
the strongest was this: the designs of the systems providers are in a
state of flux and channel counts are increasing quickly. Filters offer
considerable flexibility in both changing your design and allowing
customers to scale in the field without forklift upgrades. Hence the
importance JDS Uniphase places on this technology. Not only are systems
designs continually changing, but they are all different as equipment
vendors attempt to differentiate their products. They vary with respect
to wavelength separation, loss, crosstalk, all offering opportunities to
optimize, which a more integrated company like JDS Uniphase can do better
than competitors.
In addition, alternative solutions for WDM, such as fiber bragg grating
and arrayed waveguides, were also discussed. The company is at work on
all of these. On of the more important is interleavers. These devices
use a number of different solutions to effect a first-cut separation of
the channels to space them further apart, allowing the use of less
precise filters to multiplex and demultiplex them. With interleavers,
the designer flexibly achieves 2x the channel capability immediately, and
it appears they will be considered for most systems now being developed.
Even if filter or hybrid filter/FBG technology allows narrower channel
spacing (50 GHz is the current bogey), interleavers are still desirable,
as they will then allow the system to narrow this spacing by half when
those channels are ready to be put into use. JDS Uniphase believes that
it is important to have both filters and interleavers in the tool kit, as
system designs require trade offers and this gives JDS Uniphase the best
opportunity to help optimize. Again, having all of the technologies
allows the company to mix and match to meet customer demands.
OPTICAL SWITCHES: MESSAGE: KEY ENABLER OF THE OPTICAL NETWORK--THERE
ARE A MYRIAD OF APPLICATIONS ADDRESSED BY CURRENT TECHNOLOGY PORTFOLIO
The optical switching presentation was a real eye opener. We were
provoked into recognizing that switching is much more than the OADM and
large scale cross connects we tend to think of. There are a large number
of applications, and, in fact, switching a key enabler of the optical
network. In particular, the desire of carriers to maximize existing
fiber plant and add flexibility to provisioning by having multiple,
flexible restoration and protection choices is driving the early use of
opto-mechanical switches in larger-scale configurations. Switches are
also important for optical monitoring applications, a growing need in the
network as more functionality transfers from the electrical to the
optical level.
Another important driver for switches is the increase in the average
route length as data become a larger component of network traffic. In
voice circuits, 90% of the routes are less than 500 km long. With data,
they are primarily somewhere between 500 km and 5000 km, which creates
the need not only for high-performance components but the opportunity for
OADMs, which allow carriers to peel off smaller streams of traffic from
the bulk of it headed for large Internet points. For JDS Uniphase, OADMs
have already become a significant volume business
The presentation emphasized the usefulness of JDS Uniphase's
opto-mechanical solutions. Despite the issues regarding long-term
viability of these switches, these play an important role in the
marketplace, notwithstanding the considerable interest in competing
technologies. These opto-mechanical products remind us of 980 pump
lasers early on. Their reliability was questioned, but it turned out to
be more of a perception issue, and as data was collected, carriers became
more willing to place them in their networks.
The switching presentation appropriately started with applications and
ended with technology. The technology seemed secondary for now as
innovative systems companies grope for optical devices that can help them
realize the optical vision faster than the technology can keep pace. The
company is working on a number of these new technologies, with polymer
waveguides the one that appears to have the strongest lead in the produce
portfolio.
It sounds like JDS Uniphase is also developing a number of interesting
more direct approaches to wavelength routing by actually changing the
wavelength of the signal or using a tunable laser rather than a device
that somehow angles the light to a different port. Because of its broad
product line, the company should be able to explore this alternative
better than most.
INCREMENTAL OPPORTUNITIES SUGGEST ESTIMATES ARE TOO LOW
We heard about a number of products that we previously had not included
in our revenue mode. JDS Uniphase has, historically, set aggressive
growth goals which it has exceeded, resulting in many upward earnings
revisions. We believe recently this is due both to the
stronger-than-expected growth in the market and the incremental
opportunities that are emerging. We are reiterating our Buy rating and
$300 12-month price target.
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