II-VI to acquire Finisar for $3.2 billion

II-VI Inc. (NASDAQ:IIVI) has agreed to acquire the optical component and subsystems market share leader for approximately $3.2 billion in cash and stock. The companies expect the deal to close in the middle of next year.

For years, speculating about which company Finisar would buy next has been a favorite parlor game among optical communications industry observers. Those speculators will have to find a new game to occupy their time, as the shoe is now on Finisar’s other foot. II-VI Inc. (NASDAQ:IIVI) has agreed to acquire the optical component and subsystems market share leader for approximately $3.2 billion in cash and stock. The companies expect the deal to close in the middle of next year.

The acquisition agreement calls for Finisar’s stockholders to receive, on a pro-rated basis, $15.60 per share in cash and 0.2218x shares of II-VI common stock. That “slice of a share” is worth $10.40 based on the $46.88 closing price of II-VI’s common stock on November 8, 2018. The cash and stock payments equate to $26.00 per share of Finisar stock, a premium of 37.7% on the stock’s value when markets closed November 8. Finisar shareholders will end up owning about 31% of the combined company. II-VI expects to find the cash for the deal via a combination of cash on hand from the combined companies’ balance sheets and $2 billion in funded debt financing.

Both companies have been active in optical communications as well as 3D sensing (see, for example, “Finisar producing 100G SWDM optical transceiver for upgrades from 10 to 100 Gbps,”“II-VI to showcase ultra-low profile wide-band tunable optical filters at OFC 2018,” and “Apple awards Finisar $390 million for VCSEL R&D, manufacturing”). While II-VI touted a strengthened hand in optical communications as one benefit of the deal, it also has its eyes on other areas. “Together, we believe that we will be better strategically positioned to play a strong leadership role in the emerging markets of 5G, 3D sensing, cloud computing, electric and autonomous vehicles, and advanced microelectronics manufacturing,” explained Dr. Vincent D. Mattera, Jr., president and CEO of II-VI, via a press release announcing the deal. Overall, the combined companies could play in communications, consumer electronics, military, industrial processing lasers, automotive semiconductor equipment, and life sciences through their expertise in InP, GaAs, SiC, GaN, SiP, and diamond.

The two companies they will employ more than 24,000 people in 70 locations across the globe when the purchase concludes. The pro forma annual revenue of the two companies added together is approximately $2.5 billion of annual revenue. The companies expect to unlock $150 million of run-rate cost synergies within 36 months of closing. Such savings will come from increased efficiency in procurement, internal supply of materials and components, research and development, and marketing as well as consolidation of overlapping costs. II-VI believes the deal will enable 10% accretion in non-GAAP earnings per share for the first full year after close -- and more than double that afterward.

Mattera will remain president and CEO of the combined company after the close. Three Finisar board members will be appointed to the II-VI board, which will be expanded to 11 directors.

The deal comes in the wake of a change in senior leadership at Finisar earlier this year. Longtime CEO and chairman Jerry Rawls retired, with Michael Hurlston, a veteran of the semiconductor industry, hired to take his place (“Michael Hurlston to replace retiring Jerry Rawls as Finisar CEO”). Hurlston was tasked with setting the future direction of the company and positioning it for future growth (see “New Finisar CEO Michael Hurlston sees decisions ahead”). Apparently, he decided that combining Finisar with a company with access to a wide variety of materials processes that could be applied to products for multiple industries was the best course of action.

Pluses and minuses

The deal, much like Lumentum’s impending acquisition of Oclaro (see “Lumentum agrees to buy Oclaro for $1.8 billion”), requires approval from officials in China. Given the current tensions between China and the United States, such approvals may prove tricky, or at least time-consuming, to acquire. Nevertheless, analysts generally appear to approve of the combination.

“I think it is a good deal, provided of course the Chinese approve,” said Andrew Schmitt, founder of Cignal AI, in an email to Lightwave. “Oclaro indicate they still expect the deal to close this year, but if you look at the pricing in the markets, this isn’t the case. I think Oclaro does honestly believe this is the case, but there is a lot of uncertainty right now. II-VI didn’t address these risks in the call this morning because there really isn’t an effective way to quantify this risk. I think a lot of II-VI shareholders don’t want to be part of the ride until some of this uncertainty is resolved, and it will be interesting to see how this risk is reflected in the deal’s timeline and break up penalties.”

In a research note issued this afternoon, LightCounting saw several positives to the deal, among them (quoting here):

  • The acquisition of Finisar makes II-VI the top photonics player
  • Finisar products and internal technology complement the II-VI portfolio
  • The acquisition bolsters II-V’s effort to crack the 3D sensing market
  • II-VI’s total addressable market expands by $7.7 billion.

While much of the discussion around the deal is the opportunities it opens outside of communications, Schmitt doesn’t believe the combined company will abandon the niche. “I think these companies are trying to emphasize these other businesses because they represent more growth and are more attractive to the investment community, with an associated higher multiple. But that doesn’t mean they ignore comms business where money can be made,” Schmitt wrote. “I think FNSR slightly neglected its WSS [wavelength selective switch] business in terms of forward investments and it will be interesting to see if that changes now.”

Meanwhile, LightCounting suggests that the high multiples paid for Oclaro and Finisar may spark further consolidation within the optical components and subsystems space.

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