From Business Week: JDS-SDL: Trustbusters Will Likely See the Light
Chances are good that regulators in both the U.S. and Canada won't get in the way of this fiber-optic megamerger
As with many big merger deals, this one started with an offhand comment by one executive to another. SDL Inc. (SDLI) CEO Don Scifres called JDS Uniphase (JDSU) CEO Jozef Straus and said, "Now that you're done with E-Tek [JDS and E-Tek Dynamics had just finalized merger arrangements], we should talk getting together." The result, only a month later, was the announcement on Monday, July 10, that the two companies were merging in a $41 billion stock deal. And all that for two companies that, combined, made only $370 million in sales in 1999.
Or at least that's how the two CEOs claim the subject of merging came up. Of course, there was a lot more to it than that, including a competing bid from Corning (GLW), which Corning officials have already admitted to. Like every JDS acquisition, this one probably included lots of lawyers, take-it-or-leave-it brinkmanship, and preposterous amounts of money. But the end result is the same -- one fiber-optics company buying another for a 50% premium over the listed stock price.
At first glance, the greatest stumbling block to this deal would appear to be antitrust law. After all, JDS and SDL were two of the last three large fiber-optic equipment distributors. If they merge, that would leave Corning as the only independent distributor to compete with the new monster. Together, JDS-SDL will be the only major company to offer a complete lineup, from component parts to final products. But a closer look at the offerings of the two merging companies, and at other recent antitrust reviews in this field, suggests that legal concerns may not materialize.
LIGHT PUMP. At the heart of fiber-optics technology is a small instrument, no bigger than a breadbox, called a 980 nanometer pump laser module. This device uses a laser to provide the energy that a fiber-optic switch needs to amplify the light signals that travel down fiber-optic wires. The module consists of three important parts: the semiconductor chip that makes it go, the laser that actually performs the task, and the rest of the device, called the packaging, that integrates the other parts of the device.
JDS Uniphase's specialty in this area is manufacturing and selling the chip. SDL's main product, and the reason why its stock is currently selling at $320 a share (which gives it a price-to-1999-earnings ratio of 588) is the packaging, including the laser. JDS has made it clear that its desire to sell all the components of the 980 pump is worth $41 billion. "I talked to management, and they said, 'it's worth the money, and it's accretive to earnings, so what's wrong with that?" says S.G. Cowen analyst Jim Kedersha, who rates both stocks as a buy.
The answer to that question, at least for JDS shareholders, is nothing is wrong with that. The stock did drop 13% on Monday after the news of the merger. But that's not really all that much, considering that JDS is about to issue over $40 billion in new shares, in essence increasing the company's size by 50%.
BIG RIVALS. The shares might not have fallen at all if fears of government regulators weren't so rife. But Kedersha thinks those worries are baseless. "My guess is that their strategy will be to segment the market. They will go to the FTC [Federal Trade Commission] and say that they make two separate products, so they are in no way cornering the market," Kedersha says. "If you understand this market, you'll understand what they are saying is true."
The other factor for trustbusters: While SDL and JDS are two of the last three big independents in this field, the real competition comes from subsidiary units of major infrastructure companies that all make components. Lucent (LU), Nortel Networks (NT), and Alcatel Alsthom (ALA) all compete to sell similar lines of infrastructure equipment, and they account for nearly 75% of the market.
Unlike with other high-tech fields, FTC regulators have plenty of experience with the complicated fiber-optics market. The last two years have seen an outburst of deals in the industry, which Gartner Group expects to grow at 50% a year for the next three years, reaching $23 billion in sales by 2003. The most similar case was the 1999 purchase of E-Tek Dynamics by JDS. Similar antitrust concerns were raised then, but in the end, FTC regulators allowed the purchase to sail through with only minor changes, including the cancellation of some contracts.
"The E-Tek situation had a lot more significant antitrust problems, and its approval bodes very well," says Dave Kang, an analyst with ABN Amro who recommends both stocks with a buy rating. "In this case, there's no market overlap, which means there should be even less of an antitrust concern."
INTERNATIONAL ROADBLOCK? Of course, Canadian antitrust regulators also have to approve the deal because both JDS Uniphase and SDL have large subsidiaries based in Canada. And remember, these regulators are the same guys who stopped truckloads of U.S. magazines at the border because they didn't contain enough Canadian content.
But there seems to be little cause for worry here, either. "Canadian antitrust law is very comparable to U.S. law," says Barry Hawk, a partner at Skadden, Arps, Slate, Meagher & Flom and an expert in international antitrust law. Hawk declined to comment on this particular case, since it's possible that Skadden Arps is involved in it, but in general, he says, there's little reason to expect a different ruling from Canadian regulators. "There have been very few cases where there were different rulings by the different national regulatory bodies," he adds.
Does that mean shareholders can rejoice in the merger? After all, $41 billion is a big bone to chew on. But it's an all-stock deal, which means no dollars will actually be trading hands. In fact, the deal's value had fallen to about $35 billion by the close of Monday's market, thanks to JDS's share-price slump.
"GOOD DEAL." What's more important, says ABN Amro analyst Kang, is to look at the merger's value compared to other recent fiber-optic deals. "They're paying 50 times next year's revenues for SDL, which is about what new optical networking companies get for their IPOs," says Kang. "From that perspective, they got a good deal."
Plus, says Cowen's Kedersha, look at the industry's underlying growth, which is the real fuel for such an acquisition. "Never has there been such a demand for capital goods like there is now for optical networking equipment," says Kedersha. "Every time I make a revenue model, I have to alter it because sales estimates have increased. Every time I make a best-case scenario, it always gets better. There just doesn't seem to be any end in sight for this industry." If so, $41 billion might seem like pocket change in a few years.
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