Combined image from companies

[Image: II-VI Inc.]

On 9 November, the global materials and optoelectronics company II-VI Inc. announced that it planned to acquire the optical-technology and communications firm Finisar, in a cash-and-stock transaction valued at some US$3.2 billion. The deal, expected to be completed in the middle of calendar 2019, would create what could be the world’s largest publicly traded company involved principally in photonic technologies, with revenues amounting to some US$2.5 billion.

In stating the rationale for the giant merger, II-VI’s president and CEO, Vincent Mattera Jr., in a press release accompanying the announcement, cited the growth potential of “disruptive megatrends” driven by laser and materials innovation, in sectors such as communications, consumer electronics and the automotive business. And Finisar’s CEO, Michael Hurlston, argued that the business combination with II-VI would “enhance our ability to hit market windows that won’t stay open for long.”

Apple at the core?

The financial press, perhaps not surprisingly, has focused on the relationship between both firms and Apple Inc., and in particular on the latter’s drive to trick out its iPhone X product line with 3-D sensing capabilities driven by vertical-cavity surface-emitting lasers (VCSELs).

Last year, for example, Apple pumped some US$390 million into an investment that supported Finisar’s acquisition of a large semiconductor fab to boost VCSEL production. And II-VI has also been building its capabilities in VCSELs, not only for their potential in next-gen smartphones but also for their application in the market for autonomous-vehicle lidar.

II-VI and Finisar believe that putting together their technology platforms in GaAs and InP compound semiconductor laser design and fabrication will enable the combined entity to bring these laser products to market faster—providing them with a competitive leg up versus other companies such as Lumentum, also a big VCSEL supplier to Apple.

Markets and synergies

Beyond the VCSEL market, II-VI sees the potential for the merger to add value through scale, synergies and the marrying of complementary technologies. For example, Finisar, a market leader in optical-communications components such as transceivers and reconfigurable optical add-drop multiplexers (ROADMs), would bring a suite of products currently lacking at II-VI. That could open up billions of dollars worth of new addressable communications markets to the latter firm, particularly as 5G technology gains momentum.

In a larger sense, the deal rationale also stems from a perceived opportunity for “deep vertical integration” across the combined firms’ core technology portfolios, from engineered materials through complex, multi-component solutions. The breadth and integration, the firms suggest, could open up access to a wide variety of markets. The company also hopes to extract around US$150 million in run-rate cost cuts from the merger, through “procurement savings, internal supply of materials and components, efficient research and development, consolidation of overlapping costs and sales and marketing efficiencies.”

A photonics merger trend

The large II-VI deal marks a culmination of sorts in a merger trend in optics and photonics that’s been gathering steam since the beginning of the decade. The advisory and consulting firm Ceres, for example, identified some 1,032 M&A transactions involving photonics in the year 2016 alone, with an aggregate deal value of US$114.6 billion. These included transactions ranging from marquee deals such as Coherent’s billion-dollar acquisition of Rofin-Sinar to a wide variety of small tuck-in purchases.

More recently, announcements in addition to the II-VI/Finisar combination highlight the large deal values and dollar amounts sloshing around in the current merger pool. In March 2018, for example, II-VI/Finisar’s competitor in the VCSEL arena, Lumentum, disclosed its intention to acquire the optical components and modules company Oclaro for US$1.8 billion in cash and stock. And, at the end of October 2018, MKS Instruments, a diversified provider of industrial process and productivity technologies, reported that it would acquire laser-maker Electro Scientific Industries for around US$1 billion, with the deal expected to close in the 2019 first quarter.

For the II-VI/Finisar deal in particular, II-VI plans to use a combination of cash on hand and US$2 billion in new debt to pay for the merger. Under the terms of the deal, the company would pay Finisar stockholders US$15.60 per share in cash plus 0.2218 shares of II-VI stock per Finisar share for the purchase. That amounts to a combined value of US$26 per share for Finisar—a premium of roughly 38 percent over the latter’s closing stock price the day before the deal was announced. It would also leave nearly a third of the new combined entity in the hands of Finisar investors.

Rocky start on Wall Street

Notwithstanding the long-term rationale articulated by the companies, the immediate response of the investment community to the deal was less than positive. A number of commentators focused on the premium that II-VI would pay for Finisar, which looked a bit steep to some eyes, and on the significant leverage that II-VI would have to take on to fund the deal. Further, the acquisition still needs to pass antitrust and regulatory muster in the United States, China and other countries—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 immediate aftermath of the announcement, while Finisar shares popped up smartly in price to reflect the potential gains from the deal premium, II-VI stock sagged nearly 20 percent in value on the day of the merger announcement. And the stock fell another 15 percent on the following Monday, as II-VI was hit with negative fallout from the news that Apple Inc. was reducing shipments of semiconductor lasers from another VCSEL supplier, Lumentum, presumably owing to weakened sales expectations for Apple’s iPhone X products.

Clearly, it will take a while for the near-term stock price impacts and regulatory uncertainties to sort themselves out. One analyst, though, stressed the strong track record and positive results that II-VI has posted in recent quarters—and suggested that, in the rush to sell off II-VI shares, investors “may be throwing out the baby with the bathwater.”