JDS Uniphase Corp. (JDSU): Targeting Network Visibility & TD-LTE

Last month, JDS Uniphase Corp. announced the acquisition of Network Instruments and completed the transaction within a month, on January 7, 2014. Network Instruments supplies network performance management (NPM) and application performance management (APM) solutions, and mainly caters to the enterprise networks. This acquisition will increase the presence of JDS in network visibility related markets where Network Instruments operates.

JDS will integrate Network Instruments’ business into its network and service enablement (NSE) segment. The served available market (SAM) of Network Instruments is approximately $1.4 billion and is growing at a CAGR of 13%. The SAM of the NSE segment was $4.3 billion last year. The addition of fast-growing NPM and APM markets will help the company accelerate revenue growth of its NSE segment, which grew just 1.4% year-over-year in the company’s fiscal first quarter ended September 2013.

There are other synergies to this transaction as Network Instruments’ products cater mainly to enterprise networks and will open the market for JDS’s products and solutions. JDS can leverage its sales force for network service providers to extend the sales of Network Instruments’ products to service providers. Also, Network Instruments’ products have a high gross margin and are comparable to ITS competitor NetScout’s (NTCT) products, which have approximately 80% gross margins. JDS’s product portfolio has a gross margin of 46.3%. So the addition of Network Instruments’ products to JDS’s product portfolio will increase JDS’s overall margins.

Did the company overpay for the acquisition?

The company bought Network Instruments for $200 million. Network Instruments had revenue of approximately $40 million in 2013. This means the company bought Network Instruments at a price to sales ratio of 5. A P/S ratio of 5 might look high, but this is in line with the industry standard of 4.9. High growth in the network visibility market may explain higher valuations of companies that operate in this industry, such as Gigamon (GIMO) and Riverbed (RVBD). Gigamon became a public company in June 2013 and is now trading at a P/S ratio of 7.3, which is higher than the P/S ratio of Network Instruments. Another example is the acquisition of OPNET Technologies, which also operates in the network visibility market, by Riverbed in October 2012. Riverbed bought OPNET for $1 billion, which was 5.5 times OPNET’s revenue of $181.6 million at the time of acquisition.

TD-LTE build-out in China

Recently the Chinese government granted TD-LTE licenses to three mobile operators — China Mobile(CHL), China Telecom (CHA), and China Unicom (CHU). This will result in massive investments in the TD-LTE ecosystem, which in turn will increase demand for network devices. It is estimated that the current year’s expenditure on TD-LTE in China will be around $16.4 billion. China Mobile will be the largest spender among these companies. China Mobile is expected to increase its base stations by 500,000 in 2014. This will benefit network equipment vendors such as Huawei, ZTE (ZTCOY), and Alcatel-Lucent (ALU). In September, China Mobile awarded contracts totaling $3.2 billion to different equipment vendors. Huawei, ZTE and Alcatel together won approximately 60% of these contracts.

The expansion of TD-LTE networks will benefit JDS’s optical communications and NSE segments, which together account for around 81% of the company’s total sales. JDS is a strategic supplier of optical products and test solutions for these network equipment vendors. In November, the company won an excellent core partner award from Huawei for the third time in the last four years, leading the TD-LTE infrastructure market in award wins. Also, JDS partnered with Alcatel-Lucent to provide a transmission verification test last year in which it provided its transmission verification test units to Alcatel to ensure cell coverage in stadiums for the FIFA World Cup in Brazil. Alcatel resolved issues with signal quality and improved coverage by identifying the root cause of the issues with its test instruments. Thus, JDS is likely to benefit from the TD-LTE expansion, which will increase the demand for network equipment from these companies, which in turn will increase the demand for JDS’s products and services.

The expansion of LTE networks will also result in deployment of small cells as they enable mobile operators to increase broadband coverage and capacity. China Mobile recently announced it will deploy Alcatel’s small-cell solutions in its TD-LTE network. JDS will benefit from this, as it provides small-cell assurance solutions that enhance performance and monitoring of small-cell deployments. JDS acquired Arieso last year to enhance its small-cell test and measurement solutions. Arieso’s solutions track the data from billions of mobile-user connection events and store that data to analyze it for generating intelligent inputs for service providers. This has added a new dimension to JDS’s small-cell solutions. As deployment of small cells increases, the demand for its solutions will also increase. The deployment of small cells is expected to increase as the global expenditure on LTE Infrastructure is expected to grow at a CAGR of 61.6% in the next five years. The demand for the company’s test and optical products will increase as the LTE networks expand, which will drive the company’s revenue growth.

Conclusion

JDS Uniphase’s stock price has dropped more than 25% in the last three months. The primary reason was the company’s revenue outlook for the second quarter ending in December 2013. The company provided revenue guidance of $420 to $440 million, which is much lower than the consensus estimate of $459 million. This resulted in the sell-off of the company’s stock, which is now trading at a one-year low. However, the company has strong growth prospects for 2014

The company’s acquisition of Network Instruments will accelerate revenue growth in its NSE segment, thereby increasing the company’s overall revenue in the coming quarters. Also, investments in TD-LTE networks in China will help the company further increase revenue. The company is trading at a P/S ratio of 1.7 compared to the industry’s 2.0, which indicates that the company is undervalued at its current price and should rise.

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