JDS Uniphase: Dirt Cheap
individualinvestor.com
Research Analyst: Will Frankenhoff
"Ugly" is the only way to describe the way the Nasdaq has been trading recently.
The tech-heavy index has declined by over 20% since December 11th as a bevy of companies ranging from network switch
provider Foundry Networks (NASDAQ: FDRY - Quotes, News, Boards) to mighty Microsoft (NASDAQ: MSFT - Quotes,
News, Boards) have issued earnings warnings.
While the carnage has been widespread (and much of it deserved), one company that we believe has been unfairly punished is JDS Uniphase (NASDAQ: JDSU - Quotes, News, Boards), the world's largest manufacturer of fiber-optic components.
Shares of the company have fallen more than 30% during this period to $46 and are now down about 40% year-to-date.
Our question is: Why?
We'll grant you that JDS Uniphase carries a rich multiple (41 times forward estimates of $1.13) even after this decline.
We'll even acknowledge that the delay (until January) in the company's proposed $20.6 billion acquisition of SDL (NASDAQ:
SDLI - Quotes, News, Boards) has probably spooked some investors.
Finally, we realize that investors are increasingly concerned about a slowdown in telecom capital spending as these companies are faced with a rapidly cooling economy and a scarcity of available capital (the reason behind Merrill's recent downgrade of Cisco Systems (NASDAQ: CSCO - Quotes, News, Boards).
While all these points hold a certain amount of validity, we believe that shares of optical networking companies in general, and JDS Uniphase in particular, have been oversold.
Our reasoning?
Simply put, telecom companies cannot afford to stop building out their optical networks due to the fact that Internet traffic is currently doubling every six months and that existing copper-wire networks cannot cope with the flow.
Little wonder that market research firm RHK Inc. estimates that the worldwide optical component market will grow to $23 billion in 2003, up from $6.6 billion in 1999, representing a compounded annual growth rate of over 35%.
Pretty impressive, eh? Well, try this on for size: JDS Uniphase currently holds more than a 20% share of this rapidly growing market and when the SDL acquisition is complete the company's market share will be approximately 32% to 33%.
That brings us to another point: Investors have recently been concerned about the deal receiving regulatory approval. Our advice: Don't be.
First of all, Corning (NYSE: GLW - Quotes, News, Boards), one of JDS Uniphase's main competitors, recently said that it had no objections to the deal.
Secondly, the most obvious area to invite regulatory scrutiny is the overlap in the 980nm pump laser business. The two companies combined have a 75% to 80% share of the land-based 980nm pump market and close to 90% of the undersea market.
That being said, we believe this issue could easily be resolved by the sale of JDS Uniphase's Zurich manufacturing facility to a competitor such as Corning, Nortel (NYSE: NT - Quotes, News, Boards) or Lucent (NYSE: LU - Quotes, News, Boards).
Such a sale would not only clear the regulatory hurdle but also provide the company with a nice chunk of change (if you can call $5 billion to $6 billion change).
Here's how we figure it. Sales of 980nm pump lasers from Zurich are expected to be in the $260 million range in calendar 2001. Despite the recent multiple contraction in the overall fiber-optic sector, we believe this facility could sell for 20 times to 25 times sales ($5.2 billion to $6.5 billion) due to the advanced nature of the facility and avid bidder interest.
We know it seems like a pretty high estimate but consider that Corning recently paid $4 billion for Pirelli's optical component business which is projected to have $80 million in sales in 2001. That's a whopping 50 times sales, so we're actually being somewhat conservative.
Let's move on to the issue of valuation.
JDS Uniphase is richly valued in traditional terms trading at 41 times fiscal 2002 (JDS Uniphase's year ends in June) earnings estimates of $1.13 per share and about eight times fiscal 2002 sales of $5.9 billion.
That being said, JDS Uniphase is actually attractively valued relative to its competition.
Analysts expect JDS Uniphase to grow earnings by 40% in fiscal 2002 (without any contribution from SDL). In addition, the company has beaten earnings estimates by an average of 14% in each of the last four quarters. JDS Uniphase is now trading at less than a 5% premium to its projected growth rate.
However, rival Corning is currently trading at 39 times forward estimates of $1.42, a 81% premium to its projected earnings growth rate of 21%. Similarly, newcomer Finisar (NASDAQ: FNSR - Quotes, News, Boards) is trading at 83 times forward estimates, a 26% premium to its projected earnings growth rate of 66%. Even beaten down Cisco trades at 37 times fiscal 2002 estimates of $1.01, 42% ahead of its projected earnings per share growth rate of 26%.
In essence, this means that the market share leader (soon to be even more so) of an industry growing at a 35% compounded
annual growth rate is trading at a discount to its competitors.
To further illustrate our point, let's look at the relative multiples of some leaders in other fast growing sectors.
Take Brocade Communications (NASDAQ: BRCD - Quotes, News, Boards), the leading supplier of fiber channel switches
for Storage Area Networks (SANs), as an example. Shares of Brocade currently trade at 75 times forward estimates, a 47%
premium to its earnings growth.
While Brocade is afforded that multiple due to the fast growing nature of its market (a compounded annual growth rate of 50%+ through 2002), the same cannot be said of Microsoft. Yet even Microsoft, trading at 21 times fiscal 2002 estimates of $2.03, receives a 66% premium to its projected earnings growth rate of 12%.
We believe that once the overall rout in the Nasdaq ends and investors regain enough sense to separate the wheat from the chaff, JDS Uniphase will close these absurd valuation gaps.
Bottom Line:
At current levels shares of JDS Uniphase are attractively valued for risk-tolerant long-term investors interested in
owning the leading company is a rapidly growing market.
Good luck,
Eric |
