OT: AVNX/OPLK vs JDSU
On The Avanex/Oplink Merger
Notes From The Optical Fiber Communications Conference and Expo
By Michael Cohen, Co-fund Manager of the Alpha Analytics Digital Future Fund (ADFFX).
This week Anaheim, California was the venue for an event that many consider to be the second most important conference and tradeshow for the entire telecommunications industry behind only SuperComm. This event was the Optical Fiber Communication Conference and Exposition 2002 (OFC 2002), which is the single most important event of the year for those that specifically belong to the fiber optic communications community. The technical conference ran from March 17th to March 22nd, 2002, and the exposition hall was open from March 19th to March 21st. Many Hager Technology portfolio companies were exhibiting at this conference.
For those of us who are passionate about digital communications, the OFC is a center of the universe place to be. The sheer brainpower present here at this science-heavy conference makes it an exciting place for anyone who is curious at heart. It is also a much more international show than many others that I attend. People from Europe and Asia seem to be just as prevalent here as those of us from North America. The culture of this industry also stands in stark contrast to the casual computing culture, which is the norm for the numerous computing tradeshows that I attend near my home in the Silicon Valley. Few people wear ties at West Coast computing tradeshows, but true to the AT&T and Bell Labs roots of the North American telecommunications industry, coats and ties abound on the no-nonsense serious attendees found at both the OFC and SuperComm. It was also nice to see that the OFC is still a very well attended show. While it did seem a little smaller than in 2001, it still seemed larger than the OFC 2000 show that took place in Baltimore, Maryland. The attendance of less mainstream telecom shows like Broadband Year 2002 and SuperNet 2002 were only a remnant of their former boom-time glory, but thankfully core shows like the OFC and SuperComm are still going strong.
Numerous significant announcements come out of these shows, and this year the one that hit me as the most significant was the March 19th announcement of the Avanex (AVNX) and Oplink Communications (OPLK) merger. Sitting in on a presentation by Ken Brizel, Oplink’s Senior V.P. of Strategy & Business Development, for Fiberoptic Product News, I learned some of the details of the merger from Oplink’s perspective.
I later heard Avanex’s take on the newly formed company when I was able to spend some face time with Dr. Simon Cao, the Founder of Avanex. Prior to Avanex, Cao was one of the founders of Oplink, and before that he helped found ETEK Communications, the pure-play passive optical component company that JDS Uniphase purchased near the height of the market. When it comes to passive optical components, modules and subsystems, Simon Cao is one the most important figures in the industry. With this merger, he now has a leading role in what will likely be the largest pure-play passive components manufacturer, whose sales in passive optical components will likely only trail those of JDS Uniphase.
Far too much goes on at the OFC to explain in just one article. Therefore, this week I’m going to only focus on the most timely and important news of the Avanex and Oplink merger, in an effort to provide some color on what we can expect from the surviving combined company, which will still be called Avanex. Later in this series on the OFC, I will bring you up to date on less time sensitive issues involving telecom trends and how these will affect some of the other Hager Technology portfolio companies present at the show.
I met up with Simon Cao, the founder of Avanex, at the Avanex booth on the show floor, and I asked him some questions about the merger. The low-key and brilliant Dr. Cao explained how important their upcoming integration plans would be to the ultimate success of the merger. He explained that Oplink is a company very strong in low-cost basic passive components, and that Oplink’s strategy for growth was to build up from the component level to combine these basic components to offer their customers a greater product line of already assembled modules and subsystems.
On the other hand, Avanex has primarily been concentrating on developing and offering strategic passive optical modules and subsystems that have historically been a little less cost sensitive, because of the added functionality that they have been bringing to customer’s networks, as well as because of product differentiation. Avanex’s path for growth was then to vertically integrate and begin to expand into the component space. Eventually with Oplink moving up the food chain, and with Avanex moving down the food chain, there would have been greater overlap, and these two companies would increasingly have become competitors over time. It appears that the timing of this merger then was ideal for both parties. They seem to be at the point now where vertical integration potential is maximized and the overlap is still relatively small. It is precisely because of these product line and cost synergies that Dr. Cao stressed the importance of a successful integration strategy.
To really drive down manufacturing costs from utilizing Oplink’s Chinese-based manufacturing facilities, and to benefit from Oplink’s superior customer base and sales channels, the two companies have to successfully integrate to truly become one company and not just separate divisions. This should be geographically facilitated by the fact that their company’s headquarters are not that far apart. Avanex is located in Fremont California, and Oplink is located in San Jose, which is only about 15 miles away.
Simon Cao’s fears of poor integration led him into an anecdote where he said that Kevin Kalkhoven, the former CEO of JDS Uniphase, once said to him “Simon, one of us is going to fail,” and, according to Simon, Kevin surprisingly believed that it was going to be JDS Uniphase, because they made more fast acquisitions of companies, from all over the world, than can be successfully integrated. Simon seemed to really like this story! Probably because JDS Uniphase is now their number one competitor, and most people, including myself, believe that JDS Uniphase’s dominance in optical components has become completely unassailable since JDS Uniphase’s acquisition of SDL and ETEK, which were the last great active and passive stand alone optical components manufacturers. Active optical components are optoelectronic. They deal with electricity.
While passive optical components simply pass light. JDS Uniphase was formed by the merger of the active component manufacturer, Uniphase Corp. of San Jose, and the passive component manufacturer, JDS Fittel of Ottawa Canada. I once believed that the only company that could potentially compete with JDSU would be the active/passive combination of SDL and ETEK. Instead, JDS Uniphase bought them both!
Along these lines, I asked Simon Cao if Avanex would one day be seeking to add an active components business (of which there are no good pure plays left) to gain the synergies that JDSU enjoys. Simon just smiled and got very quiet and never really did answer that question. When I asked the same question to one of Avanex’s Sales Directors, he seemed to believe that active components were unnecessary for Avanex to successfully compete against JDSU. The synergies that JDS Uniphase loved to tout at the time of their original merger, he explained, were primarily for EDFAs (Erbium Doped Fiber Amplifiers), which use both passive and active components. Most other modules tend to be either passive or active, and Avanex is out to compete on the passive side.
During my conversation with Dr. Simon Cao, I mentioned the analogy that this merger is like having two children that grow up separate, which then ally and join forces together. To this, a big satisfied smile rolled up his relaxed and calculating face. Clearly, personal history and personal relationships played a big roll in this transaction coming about in the first place. So to see if this merger truly makes sense for Avanex shareholders and not just for personal reasons, it helps to further examine the possible synergies from this deal.
The biggest argument against this deal for Avanex shareholders is dilution. Avanex is the company that has the secret sauce, the engineering genius, the modules that really facilitate network customizability and performance. To this, we add, as a merger of equals, a company that makes commodity components thus diluting potential gains to Avanex shareholders. I believe that this is a very valid argument; however, when I really look at what Oplink brings to the table, and I consider this in light of the current industry environment, I can’t help but believe that this deal goes far beyond personal egos and that it is genuinely in the long-term best interest of Avanex shareholders.
Ken Brizel, the Senior V.P. of Strategy & Business Development for Oplink, provided me with the best reasons to be excited about this merger. At his private presentation up in the pressroom, he highlighted the synergies with an emphasis on Oplink’s contributions to the combined company. Below is a summary of what Oplink provides.
They will be bringing lots of cash. They had their IPO when the market was still hot, and the cash that they raised is still on their balance sheet. The combined company will have over $400 million in cash.
They will be bringing customers. Oplink has well over 120 customers, which will now be sales channels for Avanex’s products as well. Oplink has also been the company more focused on the Metro/Access market where capital spending is likely to come back first. The merger could accelerate Avanex’s move towards this important market segment. Oplink will also be bringing instant vertical integration to Avanex. Combined they will become what separately each company sought to be. As competition in the industry matures to compete for what little business there currently is, the immediacy of the vertical integration solution is important to provide strength and stability, so that the combined company will be ready for the inevitable continued industry consolidation and shakeouts that lie ahead for this young industry. Most importantly, Oplink provides cost reductions and manufacturing expertise. Oplink already has a large manufacturing facility in Zhuhai, China as well as an R&D facility in Shanghai, China. JDS Uniphase has been moving passive optical component manufacturing to China, and the post-boom telecommunications industry has been getting increasingly cost sensitive. The days of simply providing the best technology at any cost are over. The long-run winner on the passive component side of the industry will be the low-cost producer. China is unique in the world as a location that provides both an optically skilled workforce and a low-wage environment. China has whole universities specifically targeting this industry. Oplink is a company that is already packed with Chinese engineering expertise, even at its San Jose facility. I believe that the native Chinese element within Oplink provides it with a cultural advantage over even JDS Uniphase for manufacturing in this environment. Avanex’s engineering expertise manufactured with Oplink’s talent for cost reduction is the real beauty in this merger, and the merger could provide this synergy in a timely enough way to keep Simon Cao’s hope alive that Kevin Kalkhoven just might have been right. |
