Avanex/Oplink Merger: Tip of the Iceberg?

Avanex Corp. (Nasdaq: AVNX) and Oplink Communications Inc. (Nasdaq: OPLK), both makers of passive optical components, have agreed to merge in an all-stock deal valued at about $610 million (see Avanex, Oplink to Merge).

"Changes in the optical networking industry prompted us to take action. We plan to build a strong, competitive platform in passives as a way to branch out into other areas," said Paul Engle, CEO of Avanex in a conference call with press, analysts, and shareholders this afternoon that was broadcast from the Optical Fiber Communication Conference and Exhibit (OFC).

Although the transaction's being billed as "a strategic merger of equals," the sale involves the awarding of Avanex stock to Oplink shareholders that will result in a single entity, named Avanex, located in Fremont, Calif. (Avanex headquarters), and headed up by Engle.

Fred Fromm, CEO of Oplink, will stick around to help out during the transition and then take a seat on the board of the new company. Joe Liu, chairman of Oplink, will join Engle in what's being termed a joint chairmanship of the new company.

The deal, which is expected to close by June, was unanimously approved by the boards of both firms, but must still pass shareholder votes. Both firms have specific strengths to contribute, in the view of the executives, which will be built on in the process of merging. These include:

• Avanex R&D. Both companies have issued a vote of confidence in the ability of Avanex to take over development of new products, particularly in the area of DWDM passive components. While both companies have been developing DWDM mux/demux products, it appears the main effort will now devolve to Avanex.
  
  
• Oplink manufacturing. Oplink does 100 percent of its manufacturing overseas in China, whereas Avanex does about 50 percent outside the U.S. The firms plan to build on the cost savings of the Chinese facilities.
  
  
• Individual customer bases. While Avanex and Oplink claim there's little product overlap, the two share several key customers, including Alcatel SA (NYSE: ALA; Paris: CGEP:PA), Cisco Systems Inc. (Nasdaq: CSCO), and Nortel Networks Corp. (NYSE/Toronto: NT). Avanex also has an "in" with WorldCom Inc. (Nasdaq: WCOM) and Cogent Communications Inc. And Oplink has relationships with ADVA AG Optical Networking (Frankfurt: ADV), Agere Systems (NYSE: AGR), Corning Inc. (NYSE: GLW), JDS Uniphase Inc. (Nasdaq: JDSU; Toronto: JDU), and Lucent Technologies Inc. (NYSE: LU). Both companies hope to build a more comprehensive customer base on these existing relationships.

The process of merging will involve the "new Avanex" in a comprehensive overhaul. Focus will be maintained on the key areas cited above, and duplicate departments will be weeded out. The vendors say they don't have much product overlap except in the area of DWDM mux/demux prototypes, which will be moved under a common umbrella.

Between both companies, there are about 800 employees in the U.S. and roughly 1,100 to 1,200 in China. While neither firm is ready to announce any specific restructuring plans, Oplink's Fred Fromm says the new company will "probably have fewer" employees than the current census.

"We plan to realize $15 million in cost savings in the first full year of our [merger]," says Engle. He repeatedly refused to be specific about the future financial synergies, however. While the merger will be accretive, he won't say any more than that.

One thing both companies stress is that their merger is only the start of big things, both for the industry and the new entity. "We expect to see our competitors on much the same course," said Engle. The competitve nature of the components market and the strong trend toward optical networking as the future of telecom are helping to move the market toward consolidation.

"We were aware we had a lot of holes in our portfolio," Engle said. "The message from customers is... they would like to deal with fewer [suppliers] more effectively."

Fred Fromm concurred: "Customers are looking for alternatives to strong [established] suppliers. But they don't want to [deal] with [suppliers] who may be bankrupt in 12 months' time."

Engle and Fred Fromm also say they'll use the roughly $400 million in cash resulting from the merger to seek out other acquisitions. While both now deal in passive components that direct light signals through fiber, they're interested in eventually moving into active ones too, which require power and electricity to create and boost light signals. Presumably, such moves will help the new Avanex to compete more aggressively with the likes of JDS Uniphase Inc. Significantly, that company was also built from the combination of several smaller outfits.

The move is being hailed by analysts as the start of a stronger market.

"The right things are beginning to happen to put the communications industry on better footing. More needs to occur," writes analyst Kevin Slocum of Wit Soundview in a note today.

He says his firm has been recommending the merger of Oplink and Avanex for awhile and would have suggested that New Focus Inc. (Nasdaq: NUFO) join them. But "New Focus late last week withdrew from the product classes the three had in common," he writes, referring to that company's decision to get out of passive components (see New Focus Gets New Focus).

The merger is the second to be announced in the components industry this week. On Monday, Finisar Corp. (Nasdaq: FNSR) announced plans to acquire BaySpec Inc. in a stock deal worth about $53 million (see Finisar to Buy BaySpec ).

Finisar also appears to be ready to use consolidation as a tool to break into a broader market -- in its case, moving away from a sole focus on enterprise networking to working in the telecom market as well.

— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.comFor more information on OFC 2002, please visit: www.nottheofc.com