Challenges remain for E-TEK, JDS Uniphase integration

By STEPHEN HARDY

TECHNOLOGY

Having earned the blessing of the U.S. Department of Justice, the approximately $18-billion union of JDS Uniphase Corp. and E-TEK Dynamics is now in the honeymoon stage. But like any marriage, the process of integrating households may prove challenging.

"This is the first transaction JDS has done where there's true overlap. Transactions with overlap always hold a higher element of risk than those that don't," explains Kevin Slocum, a managing director and communications research analyst for Wit Soundview (Stamford, CT). The fact that JDS Uniphase understands E-TEK's business and technology areas should provide an advantage as the newly unified entity sorts the wheat from the chaff. However, that sorting process may prove disconcerting to some employees.

"There's an R&D activity in both operations and some of those people are working on similar projects, and you don't need that," Slocum explains. "In the optical arena, every guy with competence you can get your hands on you want these days. The question is, does a guy want to redirect his activities in another direction, or would he rather go to another shop that could use his core competence doing that same project someplace else."

However, the factor that may cause internal strife is a blessing in the eyes of outside beholders. "From a financial person's perspective, the fact that there's overlap is attractive, because that means you win in more ways than one," says Slocum. "I like the fact that there's going to be an opportunity to cut costs and improve margins by virtue of this combination."

The Justice Department demanded that the combined companies surrender contracted manufacturing capacity with four facilities before agreeing to the merger. Over a period of 90 days, JDS Uniphase and its new E-TEK assets must relinquish E-TEK's contracted rights of first refusal for thin-film-filter manufacturing resources at Barr Associates, Herrmann Technology Inc., Hoya Corp. USA, and OCJ Corp. While the newly reconstituted JDS Uniphase can still purchase manufacturing capacity from these vendors, it can't take these resources off the market by exercising E-TEK's first-refusal rights, as they would have been able to do without agreeing to the Justice Department's demands.

A Justice Department statement said that between the manufacturing capacity already contained within JDS Uniphase, particularly from its previously acquired OCLI assets, and the contracted capacity locked up by E-TEK, the combined entity would have controlled 80% of the world's manufacturing capacity in thin-film filters.

"I suppose given that it is appears as though E-TEK had a pretty strong call on the supply of those four players, I can see how they might have been concerned about that," comments Slocum. "But it looks like they worked their way around that, and it doesn't look as though the workaround was terribly onerous from a JDS perspective." Part of the touted benefits of the merger was the matching of

E-TEK's filter requirements and packaging expertise with OCLI's manufacturing resources. "There's a conversion period where OCLI has to be scaled to meet the E-TEK filter requirement, but there's also a three-month transition period that this consent decree agreement allows for. So I would not expect this to be at all onerous to them or to have undermined their perceived value of the combination," Slocum concludes.

In fact, the company management probably breathed a sigh of relief when the terms of the consent decree agreement were presented. "At least [the Justice Department] didn't impair the OCLI asset. It could be that they would have said [to JDS Uniphase that] you've got to agree to sell 20% of your OCLI output into the merchant market," Slocum points out. "So [JDS Uniphase] can fully leverage that asset that they also paid a fair amount of money for earlier this year."

Thus, JDS Uniphase escaped its anti-trust review relatively unscathed. The key for the company now will be ensuring it is equally successful in meeting the two main challenges Slocum foresees in its future. "To me, the biggest challenge is making sure that the key talent that you want to make sure you can keep is happy at the end of the day," he concludes. "And in addition to that, making sure that they can leverage the benefits of their internal filter-making capability into the E-TEK packaging asset as quickly as possible."

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