Looking for Optical Consolidation

This old dot.com darling is taking a laser like focus and may benefit from industry consolidation.

As the backbone of the internet networking companies such as Cisco (CSCO), Juniper Networks (JNPR) and Ciena (CIEN) were viewed as the relatively conservative way to invest in the late 1990’s technology boom. They were the infrastructure or “pick and shovel” plays of the build out. But of course their valuations also got swept up far too high and eventually came crashing down. Now they are the somewhat staid and reliable mature firms with steady but slower growth that trade at reasonable valuations.

But we could be seeing a fresh round of consolidation and one the companies that stands to benefit was one of the highest of fliers. Back in the dot.com heyday traders used to joke that JDS Uniphase’s ticker JDSU stood for Just Don’t Short Us. That moniker was well earned as shares rose from around $70 in 1998 to a peak of $1230 in March 2000; a mere 1650% gain in less than two years.

It now stands at a lowly $13 a share and the company continues to report losses as revenues have declined by 2% to $1.3 billion in 2014.   But the company expects to turn the corner and post a quarterly profit of 11c a share when it reports April 30th a 54c a share profit for fiscal 2015.

The improved outlook stems from two areas; expectations for increased spending and a plan to split itself in two.

Split to Create a Greater Sum of Parts

Last year a plan to split into two separate companies. One will be an optical and laser company, while the second will be a network and service enablement company. Many Wall Street analysts have felt that this is a very positive catalyst for shareholders. In addition, company management remains very confident about the prospects of the business as the need for bandwidth across the world increases. Telecommunication firms are expected to ramp up spending once they get more clarity on net neutrality rules. As a result, JDS Uniphase is seeing strong demand in the Americas for its 100G products and LTE solutions.

Recent analyst discussions with the company have been centered on the growth potential of its fiber laser offering, which generated an annualized $60 million in revenue in the most recent quarter. Wall Street expects that once the Communications and Commercial Optical Products (CCOP) segment is spun out it could be acquired by a larger player such as Cisco (CSCO) . Once that occurs I expect the core networking company will see a $50 per year boost to operating profit.

It also expects that either or both companies will immediately become acquisition targets. There had already been rumors that Finisar (FNSR) was ready to make a move but is now likely to wait until the spinoff is completed in Q2.

The industry is ripe for consolidation as smaller players such as JDSU, F5 Networks (FFIV) and Ciena (CIEN) need scale to compete with Cisco.

With shares now back down near support at the 200 dma I think this offers a good entry point for establishing a bullish position in anticipation of the spin –off and renewed takeover talk.

JDSU 040215

The Trade:

I want to keep to keep this very simple.

I’m buying the September $13 calls for $1.25 a contract

This provides enough time for the CCOP spin out and to get two more earnings reports under its belt. Initial estimates peg the standalone networking portion of JDSU as $17 a share so I’ll use that as my initial price target.

— Steve Smith

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About the Author: Steve Smith