Integration is the Key for Oclaro

Earlier this month, Oclaro, Inc (OCLR - Analyst Report) held a conference call to discuss its business going forward. Oclaro was formed by a merger of Bookham and Avanex in end-April. The company also updated on the integration of the merger. Management stated that the company is now a tier I company along with JDS Uniphase (JDSU - Snapshot Report), Opnext (OPXT - Analyst Report) and Finisar (FNSR - Analyst Report) in telecom, components and modules markets. The company aims at becoming a major force in the fiber optics industry. The integration of Bookham and Avanex is not experiencing any customer disruption and the company is on course to achieving operating synergies in the September quarter. The broad product set is aimed at metro and long haul markets.

Oclaro also announced a barter agreement with NewPort Corporation wherein the latter will acquire the NewFocus business of Oclaro’s Advanced Photonics Solutions division in exchange for the Newport Spectra Physics high power laser diodes business. Oclaro will also receive $3 million in cash proceeds. Management expects to use the amount to fund a substantial portion of transaction and integration costs. The transaction will enable Oclaro to expand its High Power Laser Diode portfolio and management expects the resultant portfolio to yield potential gross margins in the range of 40% along with a 30% improvement in the UK and Zurich wafer fab utilization.

The agreement also includes a four year agreement whereby, Oclaro will be the sole source supplier of diodes to Newport Spectra Physics for a one year period and expects to be allotted more orders in the next three years. Both businesses do not seem to have any customer overlap. Oclaro expects the acquisition to be seamless for it and Newport customers. Management currently estimates the transaction to be neutral to the adjusted EBITDA (excluding transition costs) in fiscal 2010 and accretive in 2011 to the tune of $6 million – $8 million.

Currently, it is too early to comment on how the company will shape up in the long run. Management is looking at alternatives to strengthen its product portfolio but the direction is yet not clear. Both Bookham and Avanex were relatively small and hence the merger appears to make business sense, compared to both companies running stand alone operations in the overcrowded component space. The optical industry has been severely affected by the downturn in the economy and hence fundamentals remain challenging for the companies. We maintain a HOLD rating on the stock.