Oclaro and Opnext merge. Who is next? (View in Chinese)

As we predicted in November 2011 ( ), the flood in Thailand is reshaping the global optical components industry. The merger of Oclaro and Opnext announced earlier this week is probably the first one of several more to come.  Many combinations of vendors have been considered in the past, but the flood added urgency to the industry consolidation. Oclaro and Opnext were among the most impacted by the flood with Q4 2011 revenues being down 18% and 38%, respectively.

With close to $800 million in combined 2011 revenues, the new company will be the second largest supplier of optical components and modules for the optical communications market and probably the dominant one for the telecommunication segment. Finisar retains the number one position with $900 million in 2011 sales, while JDS Uniphase and Sumitomo will compete for a place among the top three, unless they join their efforts as well. It is very likely that we will see more announcements in the coming days and weeks.

The history of other industries suggests that we should expect three main, well-diversified vendors—referred to as generalists—to eventually dominate the market. However, there will be plenty of room for specialists, vendors who focus on niche market segments or specific technologies. The optical component space always seems to generate lots of niches as technology advances. The danger for companies is to get trapped in a ditch, that is, lacking the scale and diversification of a generalist and the focus of a specialist and compete only on the basis of price.

The merger of Oclaro and Opnext places the combined entity solidly into the generalist position, at least as far as the telecom market is concerned. It holds a potential for increasing share in the datacom market as well, thanks to the combination of VCSEL technology of Oclaro with high speed edge-emitting components made by Opnext. To complete the picture, Opnext demonstrated at OFC 2012 with Hitachi Central Research Labs 1310nm LISEL (Lens-integrated Surface-emitting Laser) array operating at 25-40Gbps.  These are surface-emitting DFB lasers with an integrated lens, which combine advantages of VCSELs and DFBs into one module, offering an alternative solution for 100 Gbps short reach optics.

As usual, the deal looks great on paper, but execution will be the key. The company is planning to save $35-$45 million annually taking advantage of cost synergies, but it will take 18 months to complete restructuring. Oclaro’s team has been through so many consolidations over the last decade that doing one more should be easy. However, this deal is the biggest one and the first one with a Japanese company. Oclaro was formed by a merger of Avanex and Bookham  in early 2009.  Oclaro inherited the optical component businesses of Alcatel, Marconi and Nortel.  By acquiring Mintera in 2010, the company took advantage of the expertize of former Lucent engineers that started Mintera years earlier. The merger with Opnext adds the best of the Japanese technology to the mix.

Consolidation has been on top of the agenda for the optical component and module vendors for years. As LightCounting reported on numerous occasions ( ), the optical component industry remains too fragmented and many vendors lack scale and diversification. Many potential mergers and acquisitions were considered by the industry leaders over the last decade, but few were completed, mostly due to the lack of currency on the buyers part due to depressed stock prices. Financial markets remain suspicious of the optical vendors, as they struggle to demonstrate sustainable profitability. It is not a coincidence that recent acquisitions of Mintera by Oclaro and Ignis by Finisar, were completed during temporary surges in valuations of optical component vendors. There is no doubt that once valuations rise again, we will see more deals go through. For now, the all-stock merger is the only option preserving value for the shareholders.

The product offerings of Oclaro and Opnext are largely complementary and there are few examples where these vendors compete directly. One of the overlap is 40 Gbps and 100 Gbps line side transponders. Both companies invested heavily in acquiring this expertise and funding internal developments. At OFC2012 both vendors were marketing their latest coherent 40 Gbps DWDM transponders. Another example of a new product offered by both vendors is a tunable XFP transceiver. There is some overlap between Oclaro and Opnext legacy SONET/SDH, WDM and Ethernet products, but nothing that reduces competition significantly. However, every little improvement in this crowded market is progress.

What is next for the industry? No doubt that leading vendors will take advantage of every opportunity to grow in size, improve diversification or simply take extra capacity out of the market. The current deal may expedite the process. In the longer term, improving financial valuations should help, but timing these will remain difficult. A steady period of growth is what this industry is starved for. Letting the leaders show their might as shipment volumes ramp up and demand for high end 40/100 Gbps optics meets or exceeds our forecast ( ), demonstrate solid profitability and leave competitors in the dust. It is very likely that we will see early indications of this process in 2012, so once again, execution is the key for Oclaro. Predicting the timing of upturns in the business is tricky, but component suppliers have to be ready for it when it comes.

Given the success of Huawei and ZTE in the global market, it is probably a matter of time until Chinese optical component vendors gain real strength. The flood in Thailand clearly showed how heavily this industry relies on contract manufacturers and many of them are based in China. Combining their manufacturing capacity with the R&D expertise of Chinese engineers spells danger for the western and Japanese suppliers.  Intellectual property accumulated over the years by the established vendors offers some safety, but it will not last forever.

It is often said in business, regarding mergers, that, “Two rocks tied together – still will not float”.  But LightCounting believes that the synergy of this merger will make it a success.  Each of these companies are battle proven veterans who have stayed in the game after facing insurmountable odds.  The combination of R&D of core technologies such as lasers and end products such as amplifiers and ROADMs will give the combined company a strong technology and cost product advantage against competitors. Let us see how the competitors respond.