Is Jds Uniphase Bonkers?

Its riskiest--and costliest--buy yet gives investors pause

It's another deal for the record books. On July 10, JDS Uniphase Corp., a maker of esoteric components such as lasers used in fiber-optic networks, with sales of $1.4 billion, agreed to pay a staggering $41 billion in stock for SDL Inc., a rival optical-parts maker, whose 1999 sales were just $187 million.

That's not a typo. JDS is paying nearly 100 times SDL's expected 2000 revenues, or about $24 million for each of its 1,700 employees. The eye-popping announced purchase price was nearly double SDL's $23 billion market capitalization on July 7. Excluding telecom companies, it's the largest technology acquisition ever made.

Have the folks at JDS lost their minds? Wall Street worried they had: JDS Uniphase stock was still sagging 15% several days after the announcement, and SDL shares remained 14% below their imputed merger value, a sign traders aren't convinced the deal will go through. Moreover, JDS is still digesting some of the 17 acquisitions it made over the past five years, including the $18 billion buy of another rival, E-Tek Dynamics, which closed July 5.

Then there's the risk of antitrust problems. The E-Tek purchase underwent a four-month delay and minor concessions to gain approval from the Justice Dept. The SDL merger could face far tougher scrutiny. In some categories, the combined JDS and SDL would have as much as 80% market share. "There will be a very thorough review," predicts Roger Wery, a consultant with the firm Pittiglio Rabin Todd & McGrath.

Most worrying to investors is the deal's price tag. JDSU is using a kind of funny money, its richly priced stock. Worth some $92 billion when the SDL deal was announced--it's now down to $78 billion--JDS is likely to issue up to 352 million new shares. It says shareholders will hardly feel a dent in per-share operating earnings. In fact, on an operating basis, says Chief Financial Officer Anthony R. Muller, "we believe the deal will be accretive to earnings."

Of course, that excludes amortization of goodwill, or the still-to-be-determined difference between what JDS pays for SDL and the company's book value. But analysts buy the logic. "If you factor in the synergies from the merger and the momentum of both companies, you can justify the price and show a path to higher earnings in 2001," says Conrad W. Leifur of US Bancorp Piper Jaffray.

RUNNING THE NUMBERS. Folding in SDL and the recent E-Tek deal will dilute JDS's equity from about 800 million shares outstanding to about 1.38 billion a year from now. According to Credit Suisse First Boston, combined operating net income will more than double over the same period, from $104 million for the quarter ended June 30 to an estimated $217 million in the same quarter of 2001. That works out to be a decline of 2 cents in per-share earnings, to 16 cents.

But if a bigger JDSU can boost its quarterly revenues by roughly $200 million, or about 20%, or can raise profits by 14% through merger efficiencies, it'll be even. Growth above that is gravy.

Such math, analysts admit, doesn't account for the huge charge for goodwill that will be sitting on JDS's balance sheet. The rapid pace of change in fiber optics dictates an unusually short amortization period. The E-Tek purchase, for instance, will be spread over just five years, which adds up to more than $3 billion a year in writedowns. Neither analysts nor JDS Uniphase have yet estimated the balance sheet impact of the SDL deal, but if it's on a five-year schedule, amortization could top $8 billion per year--more than twice JDS's expected $3.5 billion revenues in 2001.

Truth be told, the company's past buying spree has taken a toll on the company's books. JDS's reported net loss of $19 million in 1997 had grown to a loss of $172 million last year. With E-Tek and SDL now on the books, that's likely to get far worse, but analysts aren't fazed. "Bulls say that goodwill amortization distorts the picture of a company's fundamental growth trend, and today's market accepts that view," says analyst James Kedersha of SG Cowen & Co. As long as it does, there are plenty more nose-bleed valuations in store.

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