JDS Swoons as Deal Faces Sharp Antitrust Scrutiny

If you liked the recent Bernie Ebbers/WorldCom action, you'll just love the latest from JDS Uniphase (JDSU Quote).

The leading maker of optical components for the Internet saw its shares slide 13% Monday after it unveiled a plan to buy rival SDL (SDLI Quote) for an eye-popping $35.7 billion in stock. While JDS was talking about smashing second-quarter earnings targets and adding capacity to slake manufacturers' thirst for its products, Wall Street was aswirl in questions about valuation, integration and even monopolization.

JDS fans remain steadfast, contending that the deal creates a stronger company and that regulators won't block it because consumers aren't directly affected. But analysts and investors warn that the deal gives JDS a stranglehold on a key market, a reality regulators are unlikely to ignore. That could put JDS shares under a cloud for some time while the deal makes its way through Washington. Indeed, SDL's 8.6% jump Monday left it about 63 points below the deal's indicated value, suggesting some skepticism on Wall Street over the deal's prospects.

Appearances Matter

Regulatory attention is likely to focus on SDL's main product, the 980 pump laser, a crucial network device that stokes light waves inside optical fibers. JDS and Corning (GLW Quote) also make these pumps and Lucent (LU Quote) has the capability, says John Lively, optical component analyst for RHK, a South San Francisco, Calif.-based research firm.

Uptrend One-year appreciation in optical-component stocks

Source: BigCharts

With established service providers and well-funded start-ups scrambling to build high-capacity optical networks, equipment makers such as Nortel (NT Quote), Ciena (CIEN Quote), Sycamore (SCMR Quote) and Lucent are scrambling to buy these pumps from JDS Uniphase, Corning and SDL.

With so much of the industry's growth riding on these pumps, antitrust officials are likely to make competition in that market the focus of their scrutiny as they assess the impact of this deal, say experts. If the combined company controls enough market share to raise prices or limit innovation, then the Justice Department "would move to stop the merger," says a Washington-based telecommunications antitrust lawyer who isn't involved with the deal. JDS didn't immediately return calls seeking comment.

"This has a little of the merger-to-monopoly appearance to it," says the lawyer. With Ebbers' acquisition-minded WorldCom recently running aground in its $115 billion buy of Sprint amid regulatory opposition, the specter of a legal battle could easily chill shareholders of fast-growing JDS.

Hungry?

Others worry that the deal is too pricey or will simply be too much for JDS to swallow. Rival Corning considered a bid but thought the "valuation was pretty high," a spokesman told Reuters. "The product portfolio did not match the associated cost of that acquisition." (TheStreet.com investigated the price question Monday.)

Still Going JDS, Corning, SDL over two months

Source: BigCharts

The major worry, says Conrad Leifur, an analyst with U.S. Bancorp Piper Jaffray, is how well JDS will be able to integrate two large acquisitions in a year. Just last month the company completed its $15 billion acquisition of E-Tek.

"They have so many balls in the air at once," says Leifur, who has a strong buy on both stocks and whose firm has no banking ties to these companies. "This could show up as signs of weakening execution -- say, if they were not getting product out on time, or if they had manufacturing glitches. This could all work its way into the financials in pretty short order."

What's Next

To be sure, Wall Streeters don't think the deal is dead. Leifur notes that JDS has a good track record for working new operations into the fold, and adds that he expects the deal to pass antitrust muster. "While JDS Uniphase and SDL will have the No. 1 market share, I think there are enough alternatives for customers that this should not be a deal killer," says Leifur.

Jeff Wrona, who manages PBHG's Technology & Communications fund, says he's comfortable with JDS's ability to prevail in the end, just miffed at the timing of the deal. Wrona has positions in both JDS and SDL.

To gain Justice Department approval for the E-Tek merger, JDS Uniphase agreed to loosen exclusive contract agreements with its customers so competitors could have greater access to the market. It's not clear if a remedy like that is possible for this deal, and lacking that sort of concession, JDS Uniphase could face having to divest itself of some operations.

"It might get interesting if JDS has to start breaking itself up," says RHK's Lively.