Gorilla In the Midst JDS Uniphase is poised to become king of the fiber-optics jungle. Is it too late to swing along?
By Christine Y. Chen

(FORTUNE Magazine) – If you scratched your head upon hearing about the largest tech merger in history, you weren't alone. JDS Uniphase's $41 billion buyout of rival SDL left a lot of people wondering whether the fiber-optic company's buying spree might have finally gotten it into trouble. After all, the SDL deal comes immediately on the heels of another massive acquisition--JDSU's $15 billion buyout of E-Tek (which closed just days before the SDL deal was announced). Most companies don't spend $56 billion in decades. JDSU did it in a few months.

Still, the SDL purchase is the biggest yet, and the most surprising. "We had always thought that SDL was the beautiful prom queen standing in the middle of the dance floor without a partner," says analyst Jim Jungjohann of CIBC World Markets, which advised JDSU on the deal.

The question for investors now becomes whether the deal makes JDSU more attractive--or less. To our thinking, it's a better investment than ever. People may argue about how the Internet gets used, but there's no doubt that Web penetration and use is increasing. That means companies building Internet infrastructure will reap rewards over the long haul. Telecom companies are spending billions to upgrade their equipment from traditional phone lines to superfast fiber-optic cables capable of transmitting voice, data, and video traffic at--literally--the speed of light. JDSU provides those telcos with the lasers, pumps, and amplifiers that pulsate and shoot the beams of light. That's why the growth potential is so huge. The optical components market totaled $6.6 billion last year and is expected to nearly quadruple to $23 billion by 2003.

The day the deal was announced, JDSU shares lost 15 points, falling to a recent low of $101. "I think it was partly a reaction by shareholders that this is a massive acquisition, directly following another large acquisition of E-Tek," says J.P. Morgan analyst Charlie Willhoit.

Arbitrageurs are also concerned that regulatory issues may hinder the deal. But despite short-term fluctuations in the stock price, most analysts think the deal will clear any antitrust hurdles. For starters, the management team seems to have a markedly different attitude from that of a certain software company in Redmond, Wash. "We always take regulatory reviews seriously," says JDSU CFO Tony Muller. He should know--he's had lots of practice. This is the company's sixth deal to undergo federal scrutiny. In each of those cases, it has shown a willingness to alter business strategies, if needed, to obtain government approval.

"A big advantage from the E-Tek deal is that they spent a lot of time with the Justice Department on this whole issue and have a good understanding as to what the government is looking for," says fund manager Robert Shoss of AIM Management, one of JDSU's biggest shareholders.

Analysts also think it's unlikely that the combined JDSU-SDL behemoth will have enough market share to monopolize any one product category. According to Paine Webber analyst David Wong, the largest product overlap will occur with a gizmo called the 980-nano-meter pump laser. But there's a worldwide shortage of them right now, and besides, Corning, Lucent, and Nortel--the other major producers of fiber-optics components--are also busy cranking them out to meet overwhelming market demand.

Like Cisco a few years ago, JDSU is finding that the best way to become a one-stop shop for its customers is through acquisitions and partnerships, as opposed to heavy amounts of R&D. But with so many different corporate cultures spread across so much space, should investors fear indigestion? "We don't digest them; we integrate them," says CFO Muller. "It's not acquisition frenzy; it's a well-thought-out strategy." And so far, it has worked. Jozef Straus, former head of JDS Fitel, stepped in as CEO when Kevin Kalkhoven retired in May, and management hasn't missed a beat. "JDS Uniphase takes the classic underpromise-and-overdeliver approach. It's an excellent method to adopt, especially when you're acquisition-hungry," says Robertson Stephens analyst Arun Veerappan. Willhoit agrees. "The company has deep management and has proven thus far that it can get the job done," he says. "The sheer growth in demand for optical components may hide any integration issues that come about."

And therein lies not only JDSU's biggest challenge but also its biggest opportunity. As with the semiconductor market three decades ago, global demand for optical components is enormous and getting bigger. Even the indexes are catching on. The S&P 500 announced on July 20 that it was dropping beleaguered Rite Aid and adding JDSU. Investors sent the stock up 20% in one day, to $128. And the management of all three companies, JDS Uniphase, E-Tek, and SDL, has indicated that earnings, which had not yet been announced at press time, would exceed consensus estimates. With forward P/E ratios upwards of 140, analysts think the market cap will only go higher. "Upwards of $500 billion in a few years? Is that a possibility? Absolutely," says Veerappan.

Who knew fiber optics could be so sexy?

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