Should Finisar Acquire Oclaro?

Finisar recently announced that it raised $117.9 million in net proceeds from its public offering of 4.14 million shares. In September of last year, Finisar acquired Broadway and it now appears to be preparing for a shopping spree in 2011. An analyst recently suggested Oclaro as a possible acquisition. Let’s take a closer look.B. Riley & Co. on Barron’s speculates that Finisar, with the recent surge in its cash balance, should acquire Oclaro for its tunable lasers:

“[W]e believe Oclaro (OCLR) would nicely complement the company’s core business. Even though Finisar is the leader in the optical-component industry, its product portfolio is fairly concentrated. It does not have tunable lasers, amplifiers and is very weak in passives. While amplifiers and passives are not very hot, tunables are.”

Oclaro (NASDAQ:OCLR) is the result of a merger between Avanex and Bookham in April 2009. Last year, Oclaro acquired Mintera, a leader in high-performance optical transport subsystems solutions for $12 million, and Xtellus, a wavelength selective switches (WSS) company for $33 million. Oclaro’s annual revenue in 2010 was $392.5 million, and it has a market cap of about $680 million. Finisar’s annual revenue in 2010 was $630 million, and it has a market cap of about $2.5 billion. Let’s now take a look at Finisar’s recent acquisitions and analyze if this speculation holds good.

Finisar’s Recent Acquisitions
Finisar acquired Broadway in September of last year for an undisclosed sum. Broadway Networks, founded in 2006, is the developer of the Ethernet passive optical network (EPON) stick, a pluggable transceiver that can enable switches and routers to connect directly to passive optical networks. Passive optical networks use fiber optics instead of copper. Finisar would be extending Broadway’s technology to the gigabit-capable passive optical network (GPON) market, a competing technology to EPON.

Karen Liu, principal analyst at Ovum, an IT advisory company, says:

“Because it is based on a ubiquitous standards-based form factor, it immediately creates a new market. Combining with a market leader like Finisar, [which] can scale this technology going forward, is a great move for the whole industry.”

Apart from this acquisition, Finisar has also invested in buying an 11% stake in tunable laser vendor Ignis for about $4.6 million. Analyst Paul Bonenfant of Morgan Keegan & Company Inc notes that:

“Finisar has apparently been using Ignis’s tunable lasers, developed by the former Syntune. An Ignis investment is the next best thing to having a captive tunables supply like JDS Uniphase Corp. and Oclaro Inc.”

But I think that after the Ignis investment last year, Finisar is unlikely to make an acquisition for tunable laser technology. The company is likely to continue making small, tuck-in acquisitions rather than a large acquisition such as Oclaro.

Finisar’s Financials
Finisar has been performing well over the past few quarters. In its recent second quarter, the company reported revenue of $240.9 million, up 65.3% y-o-y and 15.9% q-o-q. Net income was $33.8 million or $0.39 per share versus loss of $31.4 million or $0.49 per share last year and profit of $19.4 million or $0.24 per share last quarter. Gross margin increased to 34.2% from 27.3% last year and 34.1% last quarter. The company ended the quarter with $184.9 million in cash and investments. The net proceeds from its public offering will add to this balance. Total debt at the end of the quarter was $117.3 million.

Finisar experienced strong growth in higher speed products and ROADMs. Revenue from 10 Gbps or faster products increased 94% y-o-y and 14.1% q-o-q, products with less than 10 Gbps increased 30.5% y-o-y and 15.4% q-o-q, ROADM-related products including WSS increased 151% y-o-y and 27.3% q-o-q, and products for cable TV (CATV) applications decreased 28.6% y-o-y and 15.6% q-o-q.

Finisar expects WSS/ROADM growth of 20%-30% q-o-q. For the third quarter, it expects revenue in the range of $247 million to $262 million. The stock is trading around $32.12 after it hit a 52-week high of $32.72 yesterday.

JDSU’s Financials
Finisar is second to JDSU in the optical networking industry. JDSU had annual revenue of $1.364 billion in 2010. In its recent first quarter, JDSU reported revenue of $411.3 million, up 38% y-o-y and 3% q-o-q. Net income was $0.1 million or breakeven EPS compared to a loss of $31.9 million or $0.15 per share last year and net income of $1.5 million or $0.01 per share last quarter. Gross margin was 47.4% compared to 45.5% in the prior quarter and 44.0% in the first quarter of fiscal 2010. JDSU ended the quarter with $620 million in cash and equivalents.

Communications Test and Measurement revenue of $182.8 million decreased 2% q-o-q and 27% y-o-y. Communications and Commercial Optical Products revenue of $168.0 million increased 7% q-o-q and 66% y-o-y. Advanced Optical Technologies revenue of $60.5 million increased 11% q-o-q and 12% y-o-y.

For the second quarter of fiscal 2011, JDSU expects non-GAAP net revenue to be in the range of $425 million to $450 million. It expects to continue growing the business as supply constraints ease in its Optical Communications and Test and Measurement businesses. The stock is trading around $16.11 with market cap of about $3.6 billion after it hit a 52-week high of $16.13 yesterday.