JDS Uniphase (NASDAQ: JDSU) is a company focused on optical technologies, primarily within the communications sector.
Optical communications break down like this: Currently, most data and networking communication is done over what’s called twisted pair copper wires. Standard Ethernet and phone cords are twisted pair and they basically work by carrying electrical signals from one place to another. These electrical signals represent the data that’s being transmitted and is translated into, say, that picture of Jessica Simpson that you just put up as your wallpaper. BUT, there are speed limitations to twisted pair and so as we start transmitting more data and larger batches of data, it is starting to make sense to move to fiber optic communications. You may also see this referred to as FTTx, or Fiber-to-the-X, and X can be business, curb, home, etc.
As opposed to the twisted pair cables, a fiber optic cable is basically glass inside the cable. On the senders end of a fiber connection, data is translated into light signals and a laser shoots these signals over the fiber cable. In between source and destination there are a whole host of gadgets that do things like route the signals or amplify them if they're being transmitted over a long distance. On the receiving end, what’s called a transceiver catches the signals and translates them back into data. So, at the end of the day, you’ve still got your nice picture of Jessica Simpson, you just get it a whole heck of a lot faster. In fact, once you have all that extra speed, maybe you’ll look for a much higher definition picture. Because why not, right?
Anyway, JDSU makes modules and subsystems that transmit, route and receive data in light form. In addition, they also make equipment that’s used for testing fiber optic connections to make sure they are working correctly. Although a smaller portion of their revenue now (~20%), JDSU also makes optical equipment for other sectors such as defense, aerospace, instrumentation and biomedical.
JDSU was originally formed by the merger between Uniphase Corporation and JDS FITEL in 1993. Since then, they’ve been very acquisitive and a few major acquisitions they’ve made include Optical Coating Laboratory, E-TEK Dynamics and SDL.
WHAT'S BEEN GOING ON
So who isn’t excited about the idea of fiber-to-the-home??? I sure am. The speed of communications, as well as the scope of what we can transmit, will be really impressive. Well, this is where JDSU comes in – they’re providing 1) the equipment to extend fiber to households and 2) the testing gear that telecom providers are going to need to make sure the connections are working correctly.
This is where the excitement around JDSU is coming from and, quite frankly, I just haven’t heard too many people say anything negative about the actual business of JDSU. They were absolutely slammed by the tech downturn and a bunch of overprice acquisitions weighed them down even more. Now, though, momentum is starting to move in their direction and they’re aggressively focusing the business to be an end-to-end enabler of fiber communications.
To avoid being repetitive here, I’ll just reiterate: FIBER-TO-THE-X. Again, what was really little more than wishful thinking during the tech bubble is now becoming reality. During the bubble, everyone thought that fiber was going to happen – but at that point we just weren’t ready for the type of bandwidth. If you were like me, upgrading from a 56k dial-up modem to a cable hook-up seemed like upgrading from a Yugo to a Ferrari. As a result, all the fiber that was laid during the bubble was just left dark (the tech word for unused fiber).
Now, though, now we are ready. We want Desperate Housewives and The Real World and 24 and we want them when we want them. Furthermore, we want high definition programming and we want access to any movie ever made so we can watch it whenever we please. And when you’re pushing around media data like that, waiting on a 1MB connection just won’t cut it.
This is where the JDSU story gets confusing for me. The stock currently trades at $3.67 per share, which is up over 100% from what it was at this time last year. The company has historically been unprofitable, but is expected to tick just over break even for their fiscal year 2006 (which ends in June). EPS is then expected to rise to $0.05 for 2007. So if we say that they’ll have roughly $0.03 for calendar year 2006, their forward P/E is around 120x. Wow.
Now, of course JDSU just about doubled their gross margins in their December quarter over the previous year (~16% to 33%) and held operating expenses (adjusted for non-operating and one-time costs) about steady as a percentage of revenue, so they are not only growing the top-line revenue, but they’re also becoming a lot more profitable. But realistically, where does JDSU have to be to justify this $3.67 price? Based on their long-term growth rate of 22.5% and my preference to not pay for a higher PEG than 1.5x, JDSU would have to get back to a 34x P/E multiple.
To put this in perspective, using their 6% estimated net profit margin for their 2007 fiscal year (I got to this by taking the $0.05 EPS expected in 2007, multiplied it by their 1.6B shares outstanding to get to the total profit, then divided it by their $1.35B estimated revenue in that year), they would need to expand revenue to about $2.88B (notice it’s more than double the ’07 revenue estimate) to get in this range – and that’s just if the stock price stays flat! Alternatively, if their revenue grew 22% from ’07 to '08 to get to $1.65B, they would have to get their net profit margin up to 10%, not a particularly easy feat in a very competitive market. And, of course, this still also assumes that their stock price stays flat in the meantime.
Basically what I’m trying to say is that there really doesn’t seem to be any justification for the current price that JDSU is trading at. Yes, it’s a good company and yes, it’s a good industry, but a key to making good investments is knowing that getting the right price is just as important as getting the right company.
Given the excitement and hype around fiber right now, I just don’t see JDSU coming back into a range where I would find it interesting any time soon. That said, there probably will be a time when current investors get a taste of reality and that could send this guy tumbling. I’ll keep an eye out for it, but I don’t see it coming too soon.
JDSU 1-yr Chart