II-VI & Lumentum: Struggle for Horizontal Integration Supremacy

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II-VI & Lumentum: Struggle for Horizontal Integration Supremacy

A little over a year ago, this writer made a presentation to an audience of mainly CTOs and CEOs that the maturation of the traditional optics market meant that the biggest optical component suppliers would be increasingly forced to 1) enter new photonics sectors and 2) determine where exactly on the food chain to optimize profitability in each of them. Lumentum focuses more on the second goal (comprising an emphasis on outsourcing), and II-VI more on the first aim (including a greater stress on vertical integration). Despite the acquisition of Oclaro, datacom modules were not a viable business model at Lumentum, while conversely, a lot of revenue is generated by such gear at II-VI through the Finisar acquisition. In addition, a major reason for the extremely high premium II-VI paid in the deal just announced for Coherent, was to get the communications portion of its business below 50 percent. If Lumentum had been the winner, there would have been a concerted effort to increase the return on investment relatively quick on Coherent’s portion of the laser business. Despite the distinct cultures resulting in II-VI coming on top, whether it was a big mistake to overpay for what in fibeReality’s opinion is mainly an old, unexciting relic, with perhaps only a single area of high growth, excimer lasers for OLED, or if it turns out to be at a minimum, one of the shrewdest defensive moves ever, resulting in a future Harvard Business case study, remains to be seen. While Lumentum is undoubtedly feeling tremendous pain at the moment in not getting the Coherent assets, which it clearly considered quite important to its future success, not acquiring the supplier could turn out to be a blessing in disguise.

Earlier, the moves by Lumentum Holdings and II-VI/Finisar into the new consumer space in providing 3D-sensors, particularly to Apple for its iPhone, were driven by their larger motivations. Finisar, in particular, took what appeared to be a reasonable gamble at the time as a long-term, vertically integrated supplier of datacom VCSELs, that Apple would be required to settle for four-inch devices — but, of course, lost that bet. Then it went adrift for a while during a short period of new leadership. (Before obtaining Finisar, II-VI similarly grappled at least initially in producing six-inch wafers, despite purchasing a couple of new fab plants.)

After giving up on internal production of such chips (the previous JDSU was more of a second-tier VCSEL player in data communications anyway), Lumentum was very lucky to select WIN Semiconductors as its partner, to enable the six-inch variety just before the first shipments of 3D-sensors to Apple. While fibeReality’s recent intelligence gathering points to Lumentum maintaining a technology leadership role, especially with the newer LiDAR array devices, II-VI has definitely made some additional headway with share in the marketplace. It is likely only a matter of time before there is a true duopoly in the space.

Therefore, despite Lumentum’s protestations to the contrary on the timing in considering Coherent, the stakes in obtaining a greater position, such as in the industrial laser space, became even higher for itself, as well as for II-VI. Hence, there was the rather unusual, over-the-top, bidding battle for the acquirement (which included the participation of MKS Instruments) — as well as picking up other technology desired by Apple, escalating to an arguably unreasonable valuation of $7 billion-plus for Coherent.

Defenders of II-VI’s move will point to the truly passionate nature about the industry when it comes to the CEO, Chuck Mattera, and his genuine desire to construct the top optics firm in the world. The question remains whether his emotions distracted him from the necessary financial discipline, and he may even regret his decision to introduce private equity into the transaction.

When the initial, proposed deal between Lumentum and Coherent was announced, there was no doubt that “integration planning,” “divest[ing] products,” and “pull[ing] out costs from the Coherent manufacturing footprint” were all possibilities to drive higher margins. Usually, such moves are not straightforward, and they have their own risks, including the amount of time to make such changes. Nevertheless, there has to be real disappointment over not having a chance to move upstream with Coherent’s lasers to the subsystem level, as Lumentum has been successful with ROADMs in playing at the higher end.

On the positive side, Lumentum comes away from it with a bundle of cash ($217 million), no significant rise in its debt levels, and the ability to refocus its efforts on the current businesses, which should keep a good number of its executives satisfied. Concerning future growth on the commercial laser side, there is always more than one way to skin a cat, such as starting more simply with a smaller acquisition. In the meantime, its biggest competitor will be heavily in the arrears, while integrating another large company, before it has finished doing so with Finisar.