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We downgrade our recommendation on JDS Uniphase Corp. (JDSU - Analyst Report) to Neural based on the company’s high level of current valuation and the cyclical nature of the optical control industry.

Why the Downgrade?

The stock price of JDS Uniphase has moved up nearly 80.5% in the last year, significantly outpacing the S&P 500 return of just 22.6% over the same period. JDS Uniphase is currently trading at the high end of its 52-week price range. With respect to several valuation metrics, the stock is also trading at significantly higher multiples compared to the S&P 500. We believe the company is currently fairly valued and the stock price will not provide above market gains any time soon. JDS Uniphase currently has a Zacks Rank #3 (Hold).

Risk/Reward Virtually Balanced

The optical component industry has not fully recovered from the global economic downturn. Macroeconomic fluctuations may significantly affect the future prospects of JDS Uniphase. Optical component industry is highly cyclical in nature and is characterized by extreme price volatility. A weaker-than-expected market recovery will make the situation worse. Additionally, mergers among telecom carriers and equipment manufacturers may result in lower orders.

The marketfor optical networking and test measurement is emerging rapidly in terms of technological innovation and demand. JDS Uniphase’s product sales depend to a large extent on the market dynamics of the metropolitan and enterprise marketsas well as on the long-haul fiber component market.

On the other hand, the recentacquisition of U.K.-based Arieso will enhance JDS Uniphase’s mobility software portfolio. Arieso’s product suites address radio access network (RAN) monitoring and optimization to deliver effective network design and performance. The RAN optimization market size is expected to grow to $1 billion by 2015.

Most notably, Arieso has a solid list of clientele that includes several global telecom giants, such as AT&T Inc. (T - Analyst Report), Telefonica S.A. (TEF - Analyst Report) and Vodafone Group plc. (VOD - Analyst Report). JDS Uniphase paid $85 million in cash for this acquisition. We believe this deal will be incrementally positive for the company from the fourth quarter of fiscal 2013.

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