JDS Uniphase Corp. occupies a painful place in the memories of Canadian investors for its portfolio-destroying collapse after the tech bubble burst. So it's understandable that many Canadians may be unaware of the company's current status as one of the hottest tech stocks in the United States.
The maker of optical components that go into computer and telecom networks was one of the top 20 performers in the S&P 500 last year with a 77-per-cent return, and is up another 50 per cent so far in 2011. Its blowout results last week, in which it beat earnings estimates by 50 per cent, sent the shares up 27 per cent on Friday alone.
That means JDS Uniphase is no longer cheap. Before getting on board the stock this time around, investors need to figure out whether the optical-networking industry is truly shifting "from a cyclical industry to a secular growth market," as Piper Jaffray analyst Troy Jensen asserts.
Analysts such as Mr. Jensen believe the company is at the beginning of an extended period of expansion. So if JDS Uniphase's recent surge looks uncomfortably like 1999 to many investors, they may want to consider whether it's 1996 instead.
Formed from the union of Nepean, Ont.-based JDS Fitel Inc. and San Jose, Calif.-based Uniphase Corp. in January, 1999, JDS Uniphase rode a whirlwind of acquisitions and boundless optimism about the future of the telecom industry to a price-to-earnings ratio over 100 and a market capitalization of more than $140-billion (U.S.) at the height of the tech bubble.
CEO Jozef Straus, known for his trademark black beret, is "becoming what Wayne Gretzky is in hockey or Michael Jordan in basketball," a Toronto money manager told The Globe and Mail in August, 2000.
That Was Then
Alas, Mr. Straus - and that market valuation - are long gone. The company, now based in San Jose, Calif., was one of the worst-performing stocks of the 2000s, and an investor who managed to buy at its peak price is still down nearly 98 per cent, even after the stock's recent runup.
Stoking the 1990s enthusiasm for the company was the talk of "bandwidth-hungry" applications that required ever-expanding networks, supported by JDS Uniphase's products. That is the exact same sales pitch for the company today - but this time, it's different, right?
"Mobile data traffic, specifically video, is growing at about 35 to 50 per cent per year," say Alkesh Shah and Preeti Doshi of Evercore Partners. With telecom operators upgrading their networks "to handle this explosion of traffic," demand for JDS Uniphase's testing products is surging. (The Evercore analysts have a "buy" rating on the stock and a $24 target price, which the shares very nearly achieved the day after the analysts' report came out.)
Its Business
JDS Uniphase gets nearly half its revenue from testing and measurement devices used by telecom companies. Another 40 per cent comes from optical products used by network equipment makers such as Alcatel-Lucent or Cisco Systems, which in turn sell their equipment to the AT&Ts and Verizons of this world.
The company also has an "advanced optical technologies" segment, which produces thin film coatings and variable-colour printing technology used by mints to cut down on counterfeit currency. While producing just 10 per cent of revenue, the unit is nearly as profitable in dollar terms as the other two divisions, the Evercore Partners analysts note.
Analysts are keeping their eyes on another trend that could be a growth engine for the company - "gesture-recognition" devices, better known as the components that make a Wii or Microsoft Kinect game system respond to players' movements.
"We believe the gesture recognition market is developing faster than expected and this bodes well" for JDS Uniphase, says Mr. Jensen of Piper Jaffray, who has an "overweight" rating on the stock and a price target of $25. The company already provides parts for Kinect, which Mr. Jensen says shipped eight million units through the end of 2010, versus a target of five million.
"The [three million]additional units should result in $10-million to $12-million of additional revenues, but we believe the upside really underscores the traction gesture recognition is gaining," Mr. Jensen wrote. January's Consumer Electronic Show included TVs and PCs that are integrating gesture recognition technology and JDS Uniphase could be a profitable way to play the trend.
Valuations
The company appears generously valued, but not unreasonably so. Its forward price-to-earnings ratio, based on an estimate from Standard & Poor's Capital IQ is 22.7, while many other optical-networking and telco suppliers trade in the mid- to high teens. Finisar Corp., a close competitor, trades at 19.8.
But JDS Uniphase has one thing going for it that younger and smaller competitors don't have. Thanks to its legacy of losing money, it has $9-billion in net operating losses it can use to offset future profits on its tax returns. That's at least one consolation for anyone who was burned before by this stock and is thinking of giving it another chance.
Back in Canada
While JDS Uniphase is dazzling investors with its revenue gains, one of the best growth profiles in the optical-networking industry belongs to a Canadian company, EXFO Inc.
The Quebec City-based maker of network-testing equipment posted year-over-year sales growth of 63 per cent in its most recent quarter, contributing to a 55-per-cent revenue gain for the prior 12 months, according to Standard & Poor's CapitalIQ. Revenue of $65.7-million (U.S.) was above consensus expectations of $64-million.
That, combined with a gross margin of 62 per cent, led National Bank Financial analyst Kris Thompson to upgrade EXFO to "outperform" with a target price of $10 (Canadian).
Ajit Pai of Stifel Nicolaus used JDS Uniphase's blowout quarter as a reason to bump up his EXFO estimates and target price, from $12 (U.S.) to $14. (EXFO trades on both the TSX and Nasdaq.)
David Milstead
David Milstead