A Photonics Megamerger
On 9 November, the global materialsand opto electronics company II-VI Inc.announced that it planned to acquire the optical-technology and communicationsfirm Finisar, in a cash-and-stocktransaction valued at some US$3.2 billion. The deal, expected to be completedin the middle of calendar 2019, would create what could be the world?s largestpublicly traded company involved principally in photonic technologies, withrevenues amounting to some US$2.5 billion.
In stating the rationale for thegiant merger, II-VI?s president and CEO, Vincent Mattera Jr., ina press release accompanying the announcement, cited the growth potentialof ?disruptive mega trends? driven by laser and materials innovation, in sectorssuch as communications, consumer electronics and the automotive business. AndFinisar?s CEO, Michael Hurlston, argued that the business combination withII-VI would ?enhance our ability to hit market windows that won?t stay open forlong.?
Apple at the core?
The financial press, perhaps notsurprisingly, has focused on the relationship between both firms and AppleInc., and in particular on the latter?s drive to trick out its iPhone X productline with 3-D sensing capabilities driven by vertical-cavity surface-emittinglasers (VCSELs).
Last year, for example, Apple pumpedsome US$390 million into an investment that supported Finisar?s acquisition ofa large semiconductor fab to boost VCSEL production. And II-VI has also beenbuilding its capabilities in VCSELs, not only for their potential in next-gensmartphones but also for their application in the market for autonomous-vehiclelidar.
II-VI and Finisar believe that puttingtogether their technology platforms in GaAs and InP compound semiconductorlaser design and fabrication will enable the combined entity to bring theselaser products to market faster?providing them with a competitive leg up versusother companies such as Lumentum, also a big VCSEL supplier to Apple.
Beyond the VCSEL market, II-VI seesthe potential for the merger to add value through scale, synergies and themarrying of complementary technologies. For example, Finisar, a market leaderin optical-communications components such as transceivers and reconfigurableoptical add-drop multiplexers (ROADMs), would bring a suite of productscurrently lacking at II-VI. That could open up billions of dollars worth of newaddressable communications markets to the latter firm, particularly as 5Gtechnology gains momentum.
In a larger sense, the deal rationalealso stems from a perceived opportunity for ?deep vertical integration? acrossthe combined firms? core technology portfolios, from engineered materialsthrough complex, multi-component solutions. The breadth and integration, thefirms suggest, could open up access to a wide variety of markets. The companyalso hopes to extract around US$150 million in run-rate cost cuts from themerger, through ?procurement savings, internal supply of materials andcomponents, efficient research and development, consolidation of overlappingcosts and sales and marketing efficiencies.?
A photonics mergertrend
The large II-VI deal marks aculmination of sorts in a merger trend in optics and photonics that?s been gatheringsteam since the beginning of the decade. The advisory and consulting firmCeres, for example, identified some1,032 M&A transactions involving photonics in the year 2016 alone, withan aggregate deal value of US$114.6 billion. These included transactions rangingfrom marquee deals such as Coherent?sbillion-dollar acquisition of Rofin-Sinar to a wide variety of smalltuck-in purchases.
More recently, announcements inaddition to the II-VI/Finisar combination highlight the large deal values anddollar amounts sloshing around in the current merger pool. In March 2018, forexample, II-VI/Finisar?s competitor in the VCSEL arena, Lumentum, disclosed itsintention to acquire the optical components and modules company Oclaro forUS$1.8 billion in cash and stock. And, at the end of October 2018, MKSInstruments, a diversified provider of industrial process and productivitytechnologies, reported that it would acquire laser-maker Electro ScientificIndustries for around US$1 billion, with the deal expected to close in the 2019first quarter.
For the II-VI/Finisar deal inparticular, II-VI plans to use a combination of cash on hand and US$2 billionin new debt to pay for the merger. Under the terms of the deal, the companywould pay Finisar stockholders US$15.60 per share in cash plus 0.2218 shares ofII-VI stock per Finisar share for the purchase. That amounts to a combinedvalue of US$26 per share for Finisar?a premium of roughly 38 percent over thelatter?s closing stock price the day before the deal was announced. It wouldalso leave nearly a third of the new combined entity in the hands of Finisarinvestors.
Rocky start on WallStreet
Notwithstanding the long-termrationale articulated by the companies, the immediate response of theinvestment community to the deal was less than positive. A number ofcommentators focused on the premium that II-VI would pay for Finisar, whichlooked a bit steep to some eyes, and on the significant leverage that II-VIwould have to take on to fund the deal. Further, the acquisition still needs topass antitrust and regulatory muster in the United States, China and othercountries?not an inconsiderable factor, given that the Lumentum?Oclaro deal,announced in March, is still waiting for the nod from Chinese regulators.
As a result, in the immediateaftermath of the announcement, while Finisar shares popped up smartly in priceto reflect the potential gains from the deal premium, II-VI stock sagged nearly20 percent in value on the day of the merger announcement. And the stock fellanother 15 percent on the following Monday, as II-VI was hit with negativefallout from the news that Apple Inc. was reducing shipments of semiconductorlasers from another VCSEL supplier, Lumentum, presumably owing to weakenedsales expectations for Apple?s iPhone X products.
Clearly, it will take a while for thenear-term stock price impacts and regulatory uncertainties to sort themselvesout. One analyst, though, stressed the strong track record and positive resultsthat II-VI has posted in recent quarters?and suggested that, in the rush tosell off II-VI shares, investors ?maybe throwing out the baby with the bathwater.?