A Potential Threat to JDS Uniphase

In synergy with the recent consolidation trend of the broader telecommunications industry, the optical component manufacturing segment has started witnessing a consolidation trend. Yesterday, optical gear maker Oclaro Inc. (OCLR - Snapshot Report) announced that it has entered into an agreement to acquire its peer Opnext Inc. (OPXT) for a total consideration of approximately $176 million. We believe the proposed acquisition may act as a major threat for relatively bigger player of the industry, such as JDS Uniphase Corp. (JDSU - Analyst Report).

The combined Oclaro-Opnext will attain its much needed scale of economies to supply a wide range of products to telecom service providers. The merged entity can significantly reduce their costs of operations by shifting production facilities to the low-cost Asia Pacific region. Oclaro has already started moving its test and assembly facilities to Malaysia and Thailand. Opnext operations may follow suit after merger.

In fact, total revenue of combined Oclaro-Opnext was $744.7 million in 2011, which was very close to JDS Uniphase’s $755.2 million during the same period. Importantly, a devastating flood in Thailand took a huge toll on Oclaro’s revenue in 2011. Had it not been the case, the 2011 revenue of the combined entity would have surpassed the JDS Uniphase’s revenue.

The optical component industry is currently going through a downtrend. Major telecom carriers are making inventory correction and this scenario is expected to continue till mid 2012.

JDS Uniphase has projected a disappointing revenue figure for the ensuing second quarter of fiscal 2012. The company cited three reasons for this weak outlook. These are: (1) precipitous macro-economic fluctuations (2) short-term inventory correction on the part of its customers and (3) a weak seasonality generally associated with the third quarter of any fiscal year.

In this juncture, consolidation among the two smaller players of the industry may become a serious threat for JDS Uniphase going forward. We maintain our long-term Neutral recommendation on JDS Uniphase. Currently, it holds a short-term Zacks #3 Rank (Hold) on the stock.