Scott Herhold: Doing the math on JDS Uniphase deal for SDL
BY SCOTT HERHOLD
Mercury News
FROM time to time, my seventh-grade daughter asks me for advice on her math homework, a task I can still perform with honor -- though I see the ugly shadows of advanced geometry and calculus ahead.
Because I don't believe that intelligent investing should be much harder than seventh-grade arithmetic, let me talk about an issue that strikes squarely at the intersection of politics and math: Fiber-optics maker JDS Uniphase's (JDSU) proposed acquisition of SDL Inc. (SDLI), another San Jose fiber-optics component company.
After the $41 billion deal -- that's no typo -- was announced two months ago, I predicted that federal regulators would ultimately approve it, with modifications. I still feel that way. But it's time for an update.
Here's the good news in a nutshell: JDSU is doing everything it can to placate critics of the deal. It's had a lucky break in drawing the same regulators who approved its earlier acquisition of E-Tek Dynamics, another San Jose fiber-optics firm. And there are modest signs that the market is more optimistic that the deal will occur.
Here's the bad news: There's continuing speculation that JDSU may have to give up an important piece of its business to win approval by the Department of Justice. And the market, for now, appears to have cooled its long enthusiasm for JDSU.
To understand all this, begin with the refresher course in math. The deal provides that JDSU will offer 3.8 shares of its stock for every share of SDLI. With JDSU valued at $116.75 per share at the market's close on Wednesday, that means that every share of SDLI ought to be valued at $443.65.
In fact, SDLI is selling at a discount to that figure, finishing Wednesday at $376.62 per share, roughly 15 percent lower than the deal implies. You can look at this as a measure of the doubt that the deal will take place. But in fact, that margin has been coming down slightly. A month ago, the gap between the deal price and SDLI's actual price was nearly 20 percent.
All this means that the market is slightly more optimistic that the deal will take place. If regulators do not approve the deal, it's likely that SDLI investors could lose $60 or even $70 per share -- the difference between its current price and what it might have done without the deal. But in fact, both stocks have risen overall since July.
Keep in mind that JDSU is not an arrogant company. It's always polite with regulators. If Microsoft is the smart aleck in the regulatory classroom, sitting in the back and throwing spitballs at the teacher, JDSU is the assiduous pupil in the front row who volunteers to carry the teacher's briefcase. This behavior doesn't guarantee an A, but it almost certainly averts an F.
You can see this behavior in its approach to Nortel Networks, a major customer of JDSU. Nortel is understandably concerned about a concentration of the market for fiber-optic components. JDSU has responded by announcing that it is working with Nortel to assure it a supply of fiber-optics parts.
Nonetheless, it should be understood that when federal regulators get involved to this extent -- they have made a so-called ``second request'' for information from JDSU and SDLI -- they're likely to come up with some recommendations. When the government finally approved JDSU's acquisition of E-Tek Dynamics in June, for instance, it required that the new company shed certain thin-film contracts.
The fundamental issue in the JDSU-SDLI deal is a device known as the 980 nanometer pump laser. I won't bore you with the technicalities, but the pump laser is a key element for strengthening fiber-optic signals that travel long distances. Analysts have estimated that JDSU and SDLI together would control more than 80 percent of the market.
JDSU officials say the deal is being scrutinized by Justice Department officials in San Francisco, who also examined the E-Tek transaction. That is good news for JDSU, since it means that the amount of new educating it will have to do is minimized.
But there is increasing speculation among analysts and other observers that if worse came to worst, the combined company might have to reach a deal with regulators. If a divestiture were required, it would probably come from one of JDSU's existing properties, rather than SDLI's. One of those pieces is a component factory in Zurich, a property important to JDSU's bottom line.
``Clearly, there is a lot of speculation,'' said Anthony Muller, JDSU's chief financial officer. ``But it is uninformed speculation. The process of going through a Hart-Scott-Rodino (antitrust) review is very complex, and I would not want to speculate on what, if anything, we would be asked to do.''
At least some investors seemed spooked this week by the Federal Trade Commission's stance on the Time Warner-AOL deal, which bespoke a more activist government. But I think there are important differences. First, AOL-Time Warner is much more focused on the consumer, always a political land mine. Second, fiber-optics is hardly as mature a field. Lucent Technologies (LU) plans to spin off its microelectronics division. And Nortel has talked about spinning off its fiber-optics business.
If you believe the deal will happen, SDLI is still the best way of buying JDSU. But the larger issue is whether JDSU and SDLI have already seen the run-up in their stock value. Keep in mind that both stocks have gone up nearly 20 percent since the deal was announced -- and both have slipped recently. Investors who are betting that that kind of increase will continue might want to do a little self-examination. |
