Bookham, Avanex Defend Their Deal

Bookham Inc. (Nasdaq: BKHM; London: BHM) and Avanex Corp. (Nasdaq: AVNX) officials say their companies can prosper by merging, in part because the businesses have finally put an end to years of free-fall losses and cash troubles.

The all-stock deal, which values Avanex at $37.4 million, was announced yesterday along with Bookham's earnings. (See Bookham, Avanex Tie the Knot.)

The deal is expected to close within three to six months.

The companies nearly merged before, in 2006, but backed away. It appears, though, that the difficult economy, coupled with major mergers by competitors Finisar Corp. (Nasdaq: FNSR) and Opnext Inc. (Nasdaq: OPXT), forced the Bookham/Avanex hand. (See Will Avanex Hook Bookham?, Avanex/Bookham Redux, Finisar & Optium Challenge JDSU, and Opnext Steps Up With StrataLight.)

The decision took months, executives said on a conference call yesterday. And it included a field trip where, apparently, peace and harmony prevailed to the point where the top executives were convinced.

"In order to get to the absolute personal convictions that the merger was doable, we did a two-day offsite with the management team, and I think the chemistry of working together was there, the eagerness of winning together was there," Bookham CEO Alain Couder said on the conference call.

So, what exactly is so much better now than in 2006? For one thing, the financials aren't as bleak.

"Each company has done a great job of cleaning its own house," Avanex CEO Giovanni Barbarossa said on yesterday's conference call. The companies expect to spend just $7 million in merger costs, with the deal generating a positive nudge for net income within two quarters.

The numbers wouldn't have worked out so cheaply a few years ago, said Barbarossa.

While each company is still losing money, both seem to be beyond the financial crises of 2005, when they were in danger of running out of cash. (See Bookham, Avanex Shore Up and Avanex Concerns Continue.)

"The cash after one year of the new company will be more than the sum of the cash at the two companies," Couder said.

Table 1: Recent Cash Levels

Quarter ending	Bookham Cash ($M)	Avanex Cash ($M)
Dec. 2007	64.7	46.8
March 2008	54.7	53.7
June 2008	51.9	59.2
Sept. 2008	43.2	49.6
Dec. 2008	42.0	N/A*
Source: SEC filings. "Cash" includes restricted cash and short-term investments. * Avanex reports December 2008 earnings on Feb. 5.

In terms of products, the companies believe their areas of expertise line up well, without much overlap. Bookham would bring lasers, including tunable lasers, and a stronger hand in transceivers, especially at speeds beyond 10-Gbit/s. Avanex carries modulators, dispersion compensators, and wavelength selective switch-based ROADMs -- products Bookham lacks.

Bookham provides amplifier components, something Avanex doesn't have at all, while Avanex has a stronger hand in amplifier modules.

Their combined breadth could also save each company some R&D money in pursuing vertical integration, Barbarossa noted. For instance, the new company could work on 40- and 100-Gbit/s transceivers that combine fancy modulation techniques with tunable dispersion compensation, he said.

The CEOs also tried to portray their different manufacturing strategies as a plus. Bookham has poured substantial investment into building its own facility in Shenzhen, China. Avanex went the opposite route, outsourcing its manufacturing to contract manufacturers, particuarly Fabrinet Co. Ltd. (NYSE:FN)

"I don't think we want to switch to one or the other," Couder said. The new company would pursue a vague mix-and-match strategy to continue splitting products between Shenzhen and contract manufacturers -- and the Shenzhen facility does have the capacity to absorb some Avanex products, Couder said.

The companies are predicting that this quarter, ending in March, will be a low point for revenues. That's due in part to some orders that got frozen following the Nortel Networks Ltd. bankruptcy filing on Jan. 14. (See Nortel Files for Bankruptcy Protection and The Decline & Fall of Nortel Networks.)

Assuming revenues stabilize at around $110 million per quarter, Bookham and Avanex claim their combined company has a shot at reaching profitability just four quarters after the merger is completed. They laid out the argument, not with specific numbers, but with an analysis of margins. Table 2: Margin Calls

	Bookham: 12 months ended Sept. 2008	Avanex: 12 months ended Sept. 2008	Bookham+Avanex: 4 full quarters after merger	Bookham+Avanex: Long-term Target
Gross Margin	24%	28%	31%*	35%
R&D	12% of revenues	14% of revenues	12% of revenues*	13% of revenues
SG&A	17% of revenues	18% of revenues	12% of revenues*	12% of revenues
Operating Margin (non-GAAP)	(5%)	(2%)	7%*	10%
Source: Bookham and Avanex * Estimated

Some analysts on the call showed skepticism about the deal. One pointed out that Avanex is being purchased for less than its $49.6 million in cash and short-term investments (as of September 2008).

The CEOs countered by noting that stock prices are so volatile that they're ill suited for measuring the true value of the deal. "If we had agreed on market cap, we would have been negotiating every week," Couder said.

— Craig Matsumoto, West Coast Editor, Light Reading