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II-VI/Finisar: Security Over Specialization

November, 2018

fibeReality has decided to add to its initial thesis on what compelled II-VI to buy Finisar. As our title suggests, there have been a large number of SOS signals sent out in the overall optics space, concerning shrinking margins across market sectors, and specifically, regarding the excessive amount of disorder, related to several players being horribly distracted going after Apple business, with a lot of their capacity to work on new transceiver technology being eaten up. So, even if the hyperscale data center operators were to come up with the necessary capital, the technical means alone to fully conduct the R&D work on 400GbE is not currently available. II-VI has also apparently concluded that the safer route is not the one it has been on, as a rather selective component specialist without an overriding strategy, nor the direction that both Finisar and Lumentum adopted, as a result of the collapse of the data communications optical ecosystem. It goes beyond just striving to achieve a level of security in trying to become an indispensable 3D sensing supplier to Apple, but to better ensure a consistently large amount of sales moving forward with as many big, firmly-established users as possible. Just as in the fiber optic system space, long-term revenue assurance is more important now than margin generation, in order to survive as a vendor. While it is certainly not a message, which would resonate on the Street (actually, we have never seen institutional investors more underwhelmed by such a significant M&A action in the optics realm), a high level of coercion for II-VI to make this deal must have been coming from Apple, as well as from all of the big system houses.

Each of these customers had to be distressed by the loss of collaboration with Finisar’s plan to randomly divide up the company, including Chinese vendors, which would hopefully lead to no hold up in any “antitrust” considerations in China, at least with this particular merger. However, it would hardly be inconceivable that both Huawei and ZTE do not see the Lumentum/Oclaro combination as being in their interests, given the stated intentions by the CEO of the larger player, Alan Lowe, for the smaller player --potentially more than the idea of revenge, such as for the previous ban by the US government. Actually, it would probably behoove him to restate them, in light of the II-VI-Finisar combo, but we presently expect that Lumentum will continue to look to become a specialty provider of devices.

In fibeReality’s opinion, one aspect of II-VI that needs to be kept in mind is that the telecommunications world has tended to view it as being in more of a tier II category, such as regarding its reputation for the quality of its solutions. Certainly, II-VI is not mentioned in the same breath, as the traditional big four, including NeoPhotonics. Yet, the large buyers of componentry probably had no other company to turn to, in order to rescue Finisar.

Hopefully, the historic culture of Finisar, as it will be a union of firms roughly equal in size, will have a good influence on II-VI. Yet, the fact that II-VI’s current valuation is currently lower than Finisar, is a sore reminder of the lost opportunity by the latter, in not being more flexible in purchasing Oclaro. Still, perhaps Finisar saw the handwriting on the wall late last year, and maybe realized that its own immediate exit was mandatory.

There needed to be the existence of calamitous circumstances to start to push any kind of meaningful M&A in motion. While the outside-of-the-box selection of its CEO, Michael Hurlston, resulted from the ecosystem disaster, it also led to further pandemonium in the marketplace, and then Finisar getting acquired. It would be hard to imagine a significant amount of interest in any firm being motivated to buy Finisar’s various “divisions” anyway.

Of course, the philosophy of the previous CEO, Jerry Rawls, was antithetical to such a change in strategy, and mirrors more the new approach taken by II-VI. We would not be surprised if Rawls, currently a member of Finisar’s board, foresaw this chance for a withdrawal from the space.

As always, fibeReality does not recommend any securities, and this writer does not invest in any companies being analyzed by us.

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[written by Mark Lutkowitz]

 

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