Uniphase Continues to Soar

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One compelling tech story will go largely untold at the noisy

NetWorld+Interop

trade show in Atlanta this week. So let's tell it today.

Uniphase

(UNPH)

is a brainy California company involved in "dense wavelength division multiplexing" or DWDM. Uniphase's tight cadre of bullish investors boasts about products that boost the capacity of fiber-optic cables by 16 times or more.

Uniphase keeps a low profile, at least among the ink-stained crowd. Its strong profits have attracted plenty of investor attention, but not much press. The company will host a booth at the Interop marketing circus but doesn't intend to make any announcements. But the business plan is ambitious, to say the least -- Uniphase arguably dominates its niche of the promising WDM business, and its largest problem may be keeping up with accelerating demand.

One key element of the Uniphase story: It is the sole supplier of vital modulators to

Ciena

(CIEN) - Get Report

. Ciena has gained 141% since its initial offering at $23 a share on Feb. 7. (

TheStreet.com

previewed Ciena's IPO on

Jan. 3 and has detailed its progress since.)

This is a complex business. Money managers like Uniphase's brain power and ability to both build and test the advanced products. A Ciena official confirmed that Uniphase remains its sole source of modulators for certain products, adding that Ciena continues to shop around.

"Our unfair advantage is our knowledge of the photon," says CEO Kevin Kalkhoven. Uniphase has made laser products for years. In early 1995 it started selling WDM-related equipment. WDM modulators and related components have swelled to more than half of Uniphase's revenue stream.

Kalkhoven says Uniphase holds a dominant share of the market, and that his competitors face high barriers to entry. For one, Uniphase boasts a broad suite of patents. There is an elaborate testing process, lasting as long as six months for some products.

Lucent

(LU)

makes certain WDM modulators in house, but companies such as Ciena often choose to buy from a merchant like Uniphase rather than their competitor Lucent.

Still, growing pains pose no small threat to the health of Uniphase. This spring the company expanded its factory in Connecticut, and Kalkhoven says Uniphase will triple its WDM modulator production in 1997. Such a frenetic growth pace could create unexpected problems.

A year ago Uniphase encountered a glitch in its assembly line for certain cable-television products. Quite simply, the company ran out of testing capacity. On Jan. 16 Uniphase reported quarterly net income of $3.1 million, or 18 cents per share -- a 66% year-over-year gain, but still shy of some expectations. Some investors beat a retreat and drove the stock down 17% to 38 1/8 by the close on Jan. 21.

Lamoreaux Partners

, a hedge fund based in Sausalito, Calif., bought more shares at that time. Assistant portfolio manager Wendy Snow says the fund has owned the stock since the November 1993 IPO, and now counts Uniphase its No. 1 holding. Lamoreaux, up 33% in 1997, searches for small-cap issues that boast strong management and proprietary technology in a large market. Uniphase, Snow says, has a knack for making accretive acquisitions.

The company also makes interesting acquisitions. In March Uniphase cut a deal to buy the assets of the

IBM Laser Enterprise

in Zurich. The brain-heavy assets include 50 employees, 14 of them Ph.Ds. In late August, Uniphase took a 49% interest in

Indx

, an Australian concern that makes filters for WDM systems. Uniphase has options to acquire the remaining stock.

Since the company's initial public offering, Uniphase shares have climbed from 4 1/8 to 77 1/2 on a split-adjusted basis. The stock is up 144% since a recent low of 31 7/8 on March 3 and trades at about 82 times trailing operating earnings.

In the quarter ended June 30 Uniphase posted income of $9 million, or 50 cents per share, compared with a loss of $2.9 million, or 20 cents per share, one year earlier. An acquisition skewed numbers in the year-ago period.

Analyst Kevin Slocum at

SoundView

rates Uniphase stock a short-term hold and long-term buy, due to the high valuation and challenges of expanding production facilities. He also has been concerned about changes in Uniphase's relationship with

KLA-Tencor

(KLAC) - Get Report

, which distributes certain Uniphase laser products, since KLA and Tencor merged in May. But Slocum says his concerns are fading, and indicates he may raise his rating. He estimates the company will earn $1.65 per share in fiscal 1998 ending June, even with the

First Call

consensus.