This Laser Maker’s Stock Is Cheap. Why It’s a Buy.

Text dimension

For many years, the laser business has been a fragmented assortment of small gamers. There was, in reality, no laser-like focus. But a wave of mergers is altering the dynamic, creating long-term alternatives for traders.

For now, although, traders don’t know account for all of it. Industry chief

II-VI

(ticker: IIVI) not too long ago earned the profitable bid for optical part maker

Coherent

(COHR). Rival provides from rivals

Lumentum

(LITE) and

MKS Instruments

(MKSI) compelled II-VI to raise its offer several times and finally pay about $7 billion in money and inventory. II-VI’s inventory dropped from a excessive of almost $100 to the mid-$60s when the bidding conflict got here to a shut.

That was an overreaction, and II-VI inventory has rebounded to about $76 in current days. But there’s much more compelling worth within the mixture of II-VI and Coherent than the market is crediting. The inventory ought to regain the $100 stage and proceed transferring greater from there.

The tie-up is simply the most recent transfer in a wave of laser consolidation, following II-VI’s acquisition of Finisar in 2019 and Lumentum’s takeover of Oclaro in 2018. All of II-VI’s merchandise are in photonics, or the science of sunshine, for a wide range of applications. They embrace 3-D sensing applied sciences generally known as VCSEL and Lidar, which allow an Apple iPhone to recognize a user’s face and assist a self-driving automobile keep away from obstacles. The firms additionally provide key elements utilized in knowledge facilities and fiberoptic telecom networks, in addition to industrial chopping lasers, harking back to the weapon that supervillain Auric Goldfinger used on agent 007—“No, Mr. Bond, I expect you to die!” II-VI’s lasers are additionally used for precise weapon programs, together with missile focusing on.

Despite the current turbulence for the shares, business consolidation is making the core gamers into more-diversified companies higher capable of shield and develop their extremely technical mental property. Increased scale additionally provides II-VI and Lumentum larger bargaining energy with a concentrated group of shoppers.

Apple

(AAPL),

Nokia

(NOK),

Cisco Systems

(CSCO), Huawei, and

Samsung Electronics

(SSNLF) make up a essential mass of the business’s clients.

Pennsylvania-based II-VI will fork over $220 in money and 0.91 of its personal shares for every Coherent share. The mixture will almost double the scale of II-VI, which not too long ago had a market worth of about $eight billion. (As of now II-VI stays within the small-cap Russell 2000 index.) Its identify, pronounced “two six,” refers to 2 teams within the periodic desk used to make lots of its laser merchandise.

Adding Coherent will give II-VI larger publicity to finish markets like life sciences, semiconductor capital tools, and superior laser-welding purposes.

The deal is straight out of the corporate’s time-tested playbook. II-VI has accomplished some two-dozen mergers and acquisitions over the previous 20 years, from small tuck-ins to the Finisar deal.

CEO Chuck Mattera, who holds a doctorate in chemistry, got here to II-VI as a board member in 2000 after a 25 yr profession at Bell Laboratories and Alcatel-Lucent. Since then, II-VI has grown from about $150 million in annual income to an estimated $Three billion for this fiscal yr, which ends in June.

“Acquisitions are a part of our strategy,” says Mattera, who took excessive job in 2016. “Putting together these two companies creates a global leader in photonics and complements our underlying capabilities. We believe that there’s just a tremendous and compelling opportunity that the combined companies will be uniquely positioned to pursue.”

II-VI and Coherent had mixed gross sales of over $Four billion in 2020. The deal is scheduled to shut by the tip of this yr, pending regulatory approval within the U.S. and China, that are house to nearly all of II-VI’s workers and manufacturing amenities. Management expects the merger to ultimately save $250 million a yr in bills—greater than 6% of mixed 2020 revenues—and to spice up earnings per share in yr two.

Most of II-VI’s and Coherent’s finish markets are rising, as smartphones, vehicles, and vans get extra advanced, fiber-intensive 5G networks are rolled out throughout the globe, and the digital world continues emigrate to the cloud. Wall Street analysts estimate 30% gross sales development for stand-alone II-VI in pandemic-boosted fiscal 2021, adopted by 10% development subsequent fiscal yr. Coherent is seen rising revenues by about 15% in its fiscal 2021 and 2022, which finish in September.

A extra diversified portfolio ought to higher insulate II-VI from the ups and downs of its clients. No single business will symbolize greater than 50% of the mixed firm’s gross sales, and traders might reward the shares with a greater valuation a number of as a end result; II-VI inventory trades for about 18 instances estimated earnings over the approaching yr.

The common worth goal on II-VI inventory is $106, or some 40% above present ranges, with 75% of analysts score the inventory at Buy, based on FactSet.

The II-VI/Coherent deal additionally has a vote of confidence from private-equity agency Bain Capital, which took the unconventional step of buying no less than $1.eight billion of fairness within the mixed firm. Bain’s co-chairman, Steve Pagliuca, may even be a part of II-VI’s board of administrators.

Bain’s funding reduces II-VI’s required borrowing, with internet debt of $4.9 billion anticipated at closing. That’s a manageable 3.eight instances the mixed firm’s earnings earlier than curiosity, taxes, depreciation, and amortization, or Ebitda. II-VI goals to get beneath thrice inside two years.

The market was too fast to dismiss the logic of a II-VI/Coherent tie-up. Investors now get a second swing on the shares.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com