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No. of Recommendations: 3
JDSU: A super success story? You bet. A good investment? Perhaps. Likely to become a gorilla? Probably not.

Phil Weiss' analysis of JDSU's market share is largely on the mark, although there are some odd oversights (e.g why was ORTL chosen for comparison, rather than Corning (GLW), an independent supplier ten times Ortel's size?) Okay, so the picture was a bit incomplete, but the conclusion sound: JDSU is the biggest independent supplier. But why wasn't JDSU compared in detail to the captive suppliers, those divisions that are associated, however loosely, with network system houses?

JDSU's revenues are dominated by sales to telecom houses such as Lucent, Nortel, and Alcatel. Does Lucent have a strong internal supply of optical components? Absolutely. Nortel? Yes. Alcatel? You bet. Same for Fujitsu and many of the second tier Japanese companies fighting to make inroads in this market.

So how does JDSU compare to the captive suppliers? To be sure, it is now bigger (and much more richly valued) than any of the captives taken individually. Does it eclipse the captive suppliers taken in aggregate? No. In fact, JDSU does not enjoy majority market share, although its percentage share is surely in double digits.

The comparison to all suppliers, captive and independent, is important for several reasons:
- Companies such as Lucent, Nortel, and Alcatel are all investing aggressively in this lucrative market space. (Nortel has just announced a $260M investment in this area, to add to its recently announced $400M investment. Lucent is itself acquiring component suppliers - e.g. Ortel - and is increasingly touting automated manufacturing and aggressive internal investments in its microelectrnics division.) So the competition is not exactly standing still.
- JDSU makes some excellent products, but when captive suppliers are included, few are superior to all offerings of the competition. Although barriers to entry are high for several of the product lines, customers do generally have alternative suppliers to whom they can turn.
- JDSU's key customers have internal suppliers that themselves compete on the open market.

Inability on JDSU's part to wipe out their customers' lucrative in-house suppliers makes it unlikely that they could become "gorillas", dominating a critical step in the supply chain in the way that Cisco and Intel have.

JDSU is surely in an enviable position, a leading independent supplier in a red-hot, undersupplied market. Further, their product breadth could enable them to come to market with products demonstrating higher levels of functionality, raising the bar for their competitors. But as supply ramps to meet demand, will JDSU really find itself in a position to write the rules when it holds a minority share of the market and is competing with its key customers? Perhaps not.

Respectfully,
clifhanger
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No. of Recommendations: 19
Cliffhanger in #5530:
"Likely to become a gorilla? Probably not."
I agree. JDSU is a RuleMaker in the sense that they that they are twice the size of their nearest (pure) competitor, and have a repeat purchase business to sustain their "lock" on the market.
However, they do not own technology which enables them to control the market (in the way that INTC controls the market through the supply chain with their releases of the Pentium chip, and how MSFT is controlling the market through the supply chain with releases of their Windows OS). See this article for further details of this argument.
http://boards.fool.com/Message.asp?id=1360002000128002&sort=postdate

"Inability on JDSU's part to wipe out their customers' lucrative in-house suppliers makes it unlikely that they could become "gorillas""
Agreed. JDSU's biggest competitors are the in-house suppliers (eg. LU, NT).

"But as supply ramps to meet demand, will JDSU really find itself in a position to write the rules when it holds a minority share of the market and is competing with its key customers?"
Couple of points:

1) Supply isn't meeting demand right now. And supply won't be able to meet demand for the next couple of years. Even with the acquisitions of OCLI (huge manufacturer of fibre optic components) and ETEK, (ETEK owns manufacturing plants in China, Taiwan, and California), JDSU is claiming that they will still need to double their manufacturing capacity (which I still find unbelievable, by the way).
http://boards.fool.com/Message.asp?id=1150100001238000
http://www.fool.com/portfolios/rulemaker/2000/rulemaker000113.htm

2) Does a company require a majority of the market share in order to "make the rules"? The answer can be found by looking at YHOO. YHOO competes with LCOS, ATHM, AOL, and AltaVista (will be going IPO sometime in March, by the way). With all this competition, YHOO clearly does not capture over 50% of the market (the market being web portals, and spin-off markets from that such as shopping portals, and finance portals, etc.) However, that did not stop them from dominating their industry, and making the rules. What matters is that they meet the criteria which characterizes a RuleMaker. The Rule Maker criteria basically describes in detail what a Rule Maker would look like in any industry, and YHOO fits the description. JDSU pretty much fits the description as well. (I say pretty much, because there are two areas, gross margins, and flowie, where JDSU still does not "look" like a Rule Maker).

3) I think you're trying to equate RuleMakers with Gorillas. There is a distinction to be made, and just because one is a RuleMaker, that doesn't mean it is a gorilla (although gorillas are implicitly RuleMakers)
JDSU is a RuleMaker because it has met (most of) the criteria which characterizes all RuleMakers.
However, Gorillas dominate their respective markets by controlling the proprietary technology in such a way that it would cost the user (or business) to switch away to another technology.
JDSU obviously does not meet this criteria, because it faces stiff competition from GLW, LU, and NT.


We have seen indications that JDSU is a true RuleMaker.
JDSU has stated all along its intentions, and that is to become a one-stop shop for fibre optic components. That is where it will provide its value-add, by offering the most complete suite of products so that you won't need to go anywhere else.

For example, if you wished to purchase all of the folowing components:

Lithium Niobate Modulators
Source and pump lasers
He-Neon lasers
WDM couplers
Dense and wideband WDM components and modules
Optical Transmitters/receivers
Optical switches
Fibre optic mini-modems
Erbium doped Fibre Amplifiers

you would need to visit GLW, ORTL, SDLI, LU, or NT for obtaining the different components.
But you would only need to go to JDSU to obtain them all from one place. This kind of unique convenience encourages more repeat purchase business than their competition. The investor relations dept. @ JDSU has already informed me that LU, NT, and Alcatel are long time customers. I think that it is because of the variety of products that JDSU can offer them.


Thx.
Cheers,
Albert
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Phil Weiss' analysis of JDSU's market share is largely on the mark, although there are some odd oversights (e.g why was ORTL chosen for comparison, rather than Corning (GLW), an independent supplier ten times Ortel's size?)

Okay, so the picture was a bit incomplete, but the conclusion sound: JDSU is the biggest independent supplier. But why wasn't JDSU compared in detail to the captive suppliers, those divisions that are associated, however loosely, with network system houses?


The reason that I chose the competitors I chose was because those were the other pure play optic companies. Unfortunately, one difficulty that we always face when looking at competitors is that there is not detailed enough financial information available for us to analyze those companies that have their hands in a number of different pots. So, I usually defer to looking at the companies that are pure players rather than those that do many different things. It is possible that GLW would be a good choice in the future though. My initial assessment was that it had too diversified a business to provide a fair comparison. It's recent activity in the acquisition area is likely to make it heavy enough in fiber optics to compare it to JDSU. With the Etek acquisition on the table, I'll likely substitute GLW as a competitor the next time I run a Ranker.

So how does JDSU compare to the captive suppliers? To be sure, it is now bigger (and much more richly valued) than any of the captives taken individually. Does it eclipse the captive suppliers taken in aggregate? No. In fact, JDSU does not enjoy majority market share, although its percentage share is surely in double digits.

If anyone has this data, I'd be happy to use it. Right now it's not available though. From what I've learned though JDSU and LU are the 2 top dogs overall in this business (complicated of course by the fact that LU is also JDSU's biggest customer as well). In an interview I saw with LU's CEO, I believe that he said both had a market share of around 20%.

Phil

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However, they do not own technology which enables them to control the market (in the way that INTC controls the market through the supply chain with their releases of the Pentium chip, and how MSFT is controlling the market through the supply chain with releases of their Windows OS).

For JDSU there are a few things that can ultimately lead to control of the market. One is technology. Another is qualified people. It's not easy to find those expert in JDSU's business. This helps build big barriers to entry. Unless someone comes up with a new technology, JDSU's bigger fears are its current competition than new players.

For example, if you wished to purchase all of the folowing components:

Lithium Niobate Modulators
Source and pump lasers
He-Neon lasers
WDM couplers
Dense and wideband WDM components and modules
Optical Transmitters/receivers
Optical switches
Fibre optic mini-modems
Erbium doped Fibre Amplifiers

you would need to visit GLW, ORTL, SDLI, LU, or NT for obtaining the different components.
But you would only need to go to JDSU to obtain them all from one place. This kind of unique convenience encourages more repeat purchase business than their competition. The investor relations dept. @ JDSU has already informed me that LU, NT, and Alcatel are long time customers. I think that it is because of the variety of products that JDSU can offer them.


This is definitely a key emphasis of JDSU's approach to its business. It aims to be a "one stop shop." For customers there are a couple of advantages. One is that they can ultimately save costs by buying everything from one source. The costs saved are both materials and labor. Another is that purchasing from one vendor should lead to better comparability.

Phil


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Phileo in #5531:
"Supply isn't meeting demand right now. And supply won't be able to meet demand for the next couple of years. Even with the acquisitions of OCLI (huge manufacturer of fibre optic components) and ETEK, (ETEK owns manufacturing plants in China, Taiwan, and California), JDSU is claiming that they will still need to double their manufacturing capacity (which I still find unbelievable, by the way)."
You are exactly right that supply doesn't meet demand now, and likely won't for a while (years). My strong suspicion is that the market could still absorb all that JDSU could produce if they double their capacity. Growth in demand for 100 & 200 GHz systems at 2.5 & 10 Gb/s is truly phenomenal at present. RHK (leading market research firm) has many component markets more than doubling this year. This agrees with my own observations.

"I think you're trying to equate RuleMakers with Gorillas."
I appreciate your drawing this distinction - an important one. Actually I read this into TMF Grape's decision to pare Amgen from the list:
"Amgen's only shortcoming -- if you can call it a shortcoming -- is that a biotech/pharmaceutical company can never achieve gorilla status the way a Rule Making technology provider/enabler can."
As I'm sure you've gathered, my contention is that gorilla status is highly unlikely for JDSU. If I saw a plausible path to achieving gorilla status, I would likely not be contemplating closing-out my long-standing JDSU holding.

"Does a company require a majority of the market share in order to "make the rules"? The answer can be found by looking at YHOO... YHOO clearly does not capture over 50% of the market (the market being web portals, and spin-off markets from that such as shopping portals, and finance portals, etc.) However, that did not stop them from dominating their industry, and making the rules."
Excellent points. Thank you!

For my money, JDSU's success or failure as a Rule Maker will come through integration of its operations. They are alone among independent suppliers in the breadth of their product line, and are exceptionally strong in this regard even when compared to larger captive suppliers. Personally I do not buy into a significant competitive advantage in this space derived solely from common sales and distribution channels (the one-stop shop argument). Rather, I feel JDSU will start making the rules only if they are able to sell higher functionality products benefiting from the wide range of components they produce. To date, demand has been so great that they have not had the breathing room to realize synergies from their numerous scattered acquisitions, nor has this been demanded by customers or investors. Integration seems sufficiently loose that I almost view JDSU as a holding company. Tying together disparate divisions and cultures is sure to be high on top management's agenda. Success or failure here will determine their Rule Maker status, in my eyes.

Thanks again for your thought-provoking comments.
Cheers,
CH
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Phil,

From what I've learned though JDSU and LU are the 2 top dogs overall in this business (complicated of course by the fact that LU is also JDSU's biggest customer as well).
Phil,

You are correct in your facts and your thinking. I have been following JDSU for a long time. You did an excellent job covering and explaining the story. One of the best I have ever seen and you should be highly commended for your hard work. I for one thank you !! FYI JDSU spent $42 million in capex and $110 million for acquisitions during the previous quarter. The two largest customers for the quarter were Lucent at 22% of sales and Nortel at 14%. The company is currently experiencing strong demand for higher speed and higher optical power communications components. OC-192 DWDM systems (10 Gbps) are now receiving heavy demand, driving the need for more 10 gigabit modulators and higher power pump lasers for optical amplifiers. JDS Uniphase is ramping its 10 Gbps modulators, transmitters, and receivers, and increasingly pursuing 40 Gbps Technology (called OC-768). Bright future indeed!

There are serious rumors around that LU will spin off their optic division as early as this year. I would have to take a very serious look at owning this event as it is a very attractive scenario. So, you may get your comparble yet.

Again, Thank You for all you hard work!

Regards,

Robert
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I'll likely substitute
GLW as a competitor the next time I run a Ranker.<<<

Substituting Nortel, Corning and Lucent as competitors results in a similar mid 40's RM score for what its worth. Consider that it may become eaven easier for Lucent to buy components from JDSU than make them themselves.

-Mark
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