Acterna Acquisition Transforms JDSU, Aims to Bring Stability

By Daryl Inniss, Vice President, Karen Liu, Research Director and Jean Atelsek, Analyst.

JDS Uniphase's plan to buy privately held Acterna Inc., a leading supplier of broadband test and measurement (T&M) products, is intended to transform JDSU's business model, not just expand its available market and improve its finances. Acterna will become JDSU's Communications T&M Product Group, which will be headed up by Acterna president and CEO John Peeler. JDSU announced the agreement to acquire Acterna on May 24 and expects to finalize the acquisition in 3Q05.

JDSU will pay $760 million for Acterna, making this the biggest M&A transaction in the OC space since the bubble years.

Table 1 Highest-value reported optical component mergers and acquisitions

	2000	2001	2002	2003	2004	2005*
Acquisition	Corning/Pirelli OC	JDSU/IBM Transceiver	Bookham/Nortel HPOC	Bookham/New Focus T&M	Finisar/Honeywell VCSEL division	JDSU/ Acterna
Amount of transaction	$3,500 M	$340 M	$112 M	$191 M	$75 M	$ 760 M

Source: RHK Inc.
* Year to date; pending closing of the acquisition

The acquisition dwarfs others made by JDSU during the past year (including $60 million paid for datacom transceiver and VCSEL supplier E20 in May 2004) and signals an aggressive expansion into the broadband and IP space. It also puts JDSU on the fast track to profitability, thanks to Acterna's 50-percent gross margin portfolio. Meanwhile, JDSU still has plenty of cash left from its $1.5 billion war chest for further acquisitions.

Acterna acquisition portends to stabilize JDSU

Acterna is the leading supplier of test equipment to the telecom and datacom industries, including instruments, systems, and services. It emerged from Chapter 11 in October 2003, proceeded to execute an impressive turnaround, and was net-income-positive for its last fiscal year. Acterna has strong optical test products that will benefit from access to advanced JDSU components, but more interesting to JDSU is its portfolio of broadband test equipment, which encompasses different aspects of IP video, digital video, analog video, VoIP, and data services. The company has been working with network operators in the United States and Europe on triple-play service delivery and broadband networks.

As network operators push into IP-based triple-play services, Acterna's products will help JDSU meet the needs of carriers as well as systems vendors. Acterna has strong service provider relationships and will allow JDSU to diversify its customer base: whereas 30 customers (including Tier-1 vendors Nortel, Lucent, and Cisco) account for 80 percent of JDSU's communications revenues, Acterna receives 80 percent of its revenues from 250 service provider customers (including Comcast, BT, Verizon, and SBC).

Business model transformation

With the addition of the largest communications T&M player, JDSU will have a three-legged stool that implies improved market stability. Communications OC and T&M will target the same network builds but at different levels of the market, through different customers and with different cyclicality. A subtler synergy through a variety of optical technology connects JDSU's commercial products business to both. Although Finisar has also complemented its Fibre Channel optics leadership with Fibre Channel T&M, only Agilent currently has the combination of all three: optics, T&M, and commercial products (i.e. Agilent's life sciences business).

However, JDSU is not positioning itself to compete head-on against Agilent. The only similarity is a business model that is not constrained to one vertical (telecom) or to one function (components). Agilent supplies components and T&M in the datacom market but also sells components into the life sciences market. Agilent is a larger and more diverse company, not tied to any base technology such as optics. It also has major semiconductor and software businesses. If JDSU continues to add complementary lines of business according to this model, telecom semiconductors and OSS might be future targets.

Instant lift for JDSU's revenues, gross margins

The immediate effect of the acquisition will be to double the size of the total addressable market for JDSU's communications business, from $2.5 billion to more than $5 billion. Acterna posted revenues of $440 million for its fiscal year ended March 30 versus JDSU communications' revenue of $400 million during the same period. Acterna has enjoyed bookings and revenue growth for the past 5 quarters.

More important, however, Acterna puts JDSU on the fast track to profitability. With an overall gross margin of more than 50 percent in the fiscal year ended March 30, Acterna will help JDSU immediately improve its gross margin. JDSU's long-term goal is to achieve gross margins of 30-40 percent; in pursuit of this, the company has restructured its manufacturing operations and plans to reduce its head count by 1,350 employees in 2005; the Acterna acquisition is another step in this direction.

Another benefit: more even revenue distribution

Optical components and T&M have a natural synergy in terms of network deployment lifecycles. Whereas T&M revenues peak during initial installation and then taper off slowly, OC revenues are highest during wide-scale network buildouts and then drop off quickly. By incorporating T&M products, JDSU not only achieves faster time to revenue but also expands its participation in all phases of network deployment.

Challenges are simple, yet evaluation to success is complex

The challenges in this acquisition are simple to identify. These include merging the two cultures and management, integrating JDSU's existing T&M team into the new operation under John Peeler, realizing the $3M-5M-per-quarter back-office cost savings that the merger promises, and ensuring that the combined entity keeps its focus on customers.

While we don't see any major barrier to success, these challenges stress the senior management team as they cut their teeth on their first major acquisition. The sheer size of the deal, the number of employees involved (Acterna has more than 1,700 employees), and the impact on the business going forward create the potential for rewards that have not been seen by most companies in this market segment since before the bubble. But failure-if, for example, the company is mired in red ink even 2 years after this deal closes-would be a significant blow to JDSU.

The Bottom Line

JDSU used its large cash assets/reserves to expand and stabilize its business. Management is now challenged with closing this deal, integrating the two entities, and developing a profitable company. Presenting a successful business model example provides relief to others in the OC market by demonstrating that profitability and stability are possible. But, as not every company can buy its way to profitability, this approach is restricted to players with deep pockets.

Daryl Inniss has 15 years of optoelectronics experience. He is responsible for worldwide coverage of pump lasers; erbium, Raman and semiconductor optical amplifiers; dispersion compensators; dynamic gain equalizers; reconfigurable and fixed optical add/drop subsystems; and switch matrices.

Karen Liu has 20 years of experience in optical networking, including the design and marketing of components and optical networking systems. She brings expertise in optical systems architecture, transmission technology, optical network modeling, optical components technology, and the introduction of new technology into products and networks.

Jean Atelsek provides analysis of the optical components market by tracking revenues, market share, and financial transactions in the optical components area. She joined Ovum-RHK as a Senior Editor in 2002.