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Methode Taps into Optical Madness

Light Reading
News Analysis
Light Reading

There is probably no better demonstration of how financial engineering is used to take advantage of market trends than the Methode Electronics (http://www.methode.com; Nasdaq: METHA) spinoff of Stratos Lightwave (http://www.stratoslightwave.com; proposed Nasdaq symbol: STLW) as an IPO.

Methode, an Illinois-based electronics manufacturer, isn't exactly a high-growth technology company. For the fiscal year ending April of 2000, revenues rose four percent from the previous year to $428.7 million. And net income fell six percent on a year-to-year basis to $30.9 million. But Methode had a high-growth optical sub-systems business--now called Stratos Lightwave--whose results were buried within its books. Stratos reported $71.8 million revenues for the fiscal year ending April 30, 2000, which represents 52 percent growth over the 1999 numbers. It also showed a net profit of $3.8 million.

Stratos shares are being offered in an Initial Public Offering (IPO) that is expected to be priced on Monday night and start trading on Tuesday. It's a classic story of "unlocking value." With the valuations of optical companies skyrocketing, Methode executives saw a good opportunity to "carve out" the high-growth Stratos and grab a piece of those optical multiples--where companies trade as high as 20 times forecasted annual revenues--while the public hungers for anything optical.

On Monday night, the investment bankers on the Stratos deal--led by Lehman Brothers, are expected to price 8.75 million shares of Stratos at between $16 and $18, raising up to $157.5 million dollars. After the IPO, Stratos could have up to 64 million shares outstanding, depending on how many shares get distributed to bankers as an over-allotment in this IPO, wich appears to be in heavy demand.

Prominent IPO watchers at sites such as Worldfinancenet.com (http://www.worldfinancenet.com) and IPO.com (http://www.ipo.com) have this IPO tagged as hot, meaning shares could double or triple in the aftermarket. Say the IPO prices at $18 and then trades to $50 on Tuesday. That would leave Stratos with a market capitalization of around $3 billion. Methode, the parent company, already trades on Nasdaq, and its market capitalization is only $1.5 billion. That means that the market could end up valuing Stratos, the small optical slice of Methode, at at a price that's higher than that of its parent company. Methode will own 86 percent of Stratos after the offering.

"A solid aftermarket performance is expected because of the hot vibes coming from optical technology," says Jeffrey Hirschkorn, senior market analyst with IPO.com. "Still, one note of caution is the relationship with Methode Electronics and negative problems that generally occur from carve-outs. Down the road, Methode plans to sell its remaining stake and let Stratos stand on its own two feet and at that point analysts feel the real test will begin."

Some investors have been buying stock in Methode in order to take an indirect pre-IPO stake in Stratos. Methode shares have been on a roller coaster of late, rising nearly 10 percent last week. They are trading off their peak of $66, however, which was attained following the initial annoucement of the Stratos spin-off, made in February.

This is not the only time recently when investors have found a backdoor into an optical IPO. See Nanovation Prepares the Ground for an IPO and Investors Find Route into Corvis.

--by R. Scott Raynovich, Executive Editor, Light Reading (http://www.lightreading.com)

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