JDSU: Future Stock?


By Olga Kharif The telecommunications slump continues to pummel JDS Uniphase (JDSU). Its sales fell 72%, to $262 million, in the third quarter of 2002 from $920 million in the year-ago period. Over the past two years, the world's largest maker of optical components used in telecom networks has laid off more than two-thirds of its workforce and closed 18 of its 41 plants. That's pretty much the norm for the battered telecom-equipment sector.

Small wonder few analysts recommend buying the stock right now. On May 6, it hit a new 52-week low of $3.39, down more than 80% from its 52-week high of $24.21. However, a handful -- Merrill Lynch for one -- rate it a long-term buy.

JDSU does stand out among telecom players in one key way -- it's upping the ante on research and development. In the past quarter, it spent 22% of sales on R&D -- double what it spent in the third quarter of 2001. True, the actual dollar figure was smaller because of the dramatic sales decline, but most of JDSU's competitors have been sharply cutting R&D spending as a percentage of sales.

A BIG IF. That's one of a handful of signs that JDSU isn't worried about survival. In fact, it's already positioning itself for an eventual telecom turnaround, which some analysts see happening by the middle of 2003. CEO Jozef Straus has made acquisitions to diversify JDSU's portfolio -- the broadest in the industry. He's also working to reduce its reliance on telecom customers.

If Straus's strategy works, JDSU could exit the downturn with higher market share, fewer rivals, and better technology, says John Lively, an analyst with optical-equipment consultancy RHK.

That's a big if, of course. JDSU's sales may be slow for some time even if they stop declining in the current quarter. Consider that JDSU's key customers include Nortel Networks (NT), Alcatel (ALA), and Lucent Technologies (LU), all severely battered telecom giants. In an Apr. 24 earnings conference call, Straus admitted he has no clear visibility on when the telecom sales slump will end.

DEBT-FREE. The biggest blow to JDSU could come if any of its customers go bankrupt. As of its most recent quarter, no single buyer of its gear accounted for more than 10% of JDSU's sales. But 10 big telecom equipment makers accounted for 70% of its telecom-related sales.

So what's working in JDSU's favor? A clean balance sheet, for one. As of its third quarter, which ended Mar. 30, it had $1.56 billion in cash and cash equivalents and no debt. That appeals to many customers that have grown weary of suppliers going bankrupt midway through a project. It also gives JDSU significant breathing room if it needs financing.

JDSU is also gaining market share during the downturn. It holds a 50% share of the global optical-components market. That's up from 40% last year, according to RHK. And JDSU will add an additional 5% to 10% in market share in the next year as its smaller rivals disappear and its new products take off, estimates Sam Kingston, an analyst with investment bank Dresdner Kleinwort Wasserstein.

BECOMING A COMMODITY? Straus also can expect higher profits than his rivals earn due to JDSU's emphasis on selling modules, parts assembled out of several smaller components. For equipment makers, buying modules can be 30% cheaper than buying the individual components, estimates Gabriel Lowy, an analyst with Credit Lyonnais Securities. And sales are growing in this market -- 40% of JDSU's telecom revenues in the third quarter came from modules, up from only 25% in the quarter before, says Tony Carbone, an analyst with JP Morgan.

The downside: To make modules, JDSU is standardizing more of its components. That means lower-cost rivals can make compatible components, and JDSU could face additional price pressure from commoditization, points out Lowy. Straus & Co. isn't worried, however. "We've got the technology and the knowhow to remain competitive," says Jeff Wild, vice-president for corporate communications at JDSU.

Besides, Straus has started to move the business away from telecom, which accounts for 60% of total sales, Lowy estimates. Some 20% come from JDSU's pigment-production business. These pigments are largely used to print legal currencies and are hard for counterfeiters to duplicate. The remaining 20% comes from sales of optical and electronic parts used in nontelecom products.

BROADER PORTFOLIO. In January, JDSU acquired for an initial payment of $340 million in cash and stock an IBM unit that manufactures optical transceivers. The devices, used to convert electrical signals into optical ones, are used in corporate networks, and companies are still buying them despite the telecom slump. The transceiver market will grow 15% this year, to $530 million, estimates Tom Hausken, a telecom analyst with Strategies Unlimited in Mountain View, Calif.

JDSU is also beefing up its portfolio for better times to come. In April, it acquired Scion Photonics, in which it held a minority interest, for a firesale price of $43 million in cash. Scion makes several components used in next-generation, superfast optical networks. The acquisition will replace JDSU's internal efforts on these components, which have fallen behind. JDSU plans to close its plant that develops these products in Columbus, Ohio.

Cost-cutting still remains the order of the day. On Apr. 24, Straus announced layoffs of 2,000 more employees, bringing the JDSU headcount to about 8,000 workers -- bringing total annual cost savings from restructurings to $1 billion. Analysts speculate that JDSU might exit more of its less profitable product lines. The result: It should break even in a year, analysts estimate. And long term, JDSU is poised to grow at 10% to 12% a year, claims Lowy.

ANGRY SHAREHOLDERS. That's not to say profitability is a given. Burdened with a year's worth of excess inventory, the global telecom-components market will fall 60% this year, to $2.5 billion, Hausken says. JDSU also faces numerous shareholder lawsuits, alleging that its executives' comments contributed to the stock's overblown share price. JDSU won't discuss the lawsuits.

The class actions generally represent shareholders who invested into the common stock from mid-1999 to mid-2001, in the midst of JDSU's boom. The suits allege that, in this period, JDSU executives talked of accelerating demand and of the great visibility they had of future demand, which led to inflated prices of JDSU's shares.

Remember, JDSU is still in the red. It should book about $1.1 billion in revenues for the fiscal 2002, which ends June 30, according to Deutsche Bank Securities, with significant losses of $166 million (11 cents a share). In fiscal 2003, JDSU should book $925 million in revenue and record a loss $120 million (8 cents a share), according to Deutsche. Yet, the stock is still trading at nearly six times 2003 sales, a significant premium over the usual metric of three to four times sales for even the most solid companies in the sector.

This might be a case where a much-heralded wunderkind of the high-tech revolution survives and prospers. The question investors would have to answer is: When will the turnaround come? Kharif covers technology for BusinessWeek Online


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