By Christopher Shim, Rohan Shah (University of Cambridge), Ho Hai Ivan Chung, Kevin Lee (Hong Kong University of Science and Technology)
Overview of the deal
Implied Equity Value:
Total Transaction Size: $5.7 Billion
Closed date: January 19, 2021
Acquirer Advisor: Bank of America
On January 19th, photonic product manufacturer Lumentum Holdings Inc. announced that it has agreed to acquire its rival, Coherent Inc., in a cash-and-stock deal valued at $5.7 billion. Coherent holders will receive $100 in cash and 1.1851 Lumentum shares for each Coherent share, with a total of $214 in value. This reflects a nearly 50% premium to Coherent stock price before the announcement.
This acquisition is a big move in consolidating the photonic technology market which covers innovative areas such as cloud and networking, advanced manufacturing and 3D Sensing. It further strengthens the leading position of Lumentum and expands its product range. Within the photonics and laser market, Coherent has a leading position in Microelectronics, Precision Manufacturing, Instrumentation, and Aerospace & Defense while Lumentum is strong in telecom, datacom, and 3D sensing businesses. Thus, the acquisition can create a combined company with a larger business scale, wider market reach and diversified photonic product range.
After the transaction, Coherent shares will own about 27% of the combined company and two current Coherent directors will be added to the Lumentum board. The deal is expected to be accretive in the first year after closing and to generate more than $150 million in annual run-rate synergies within 24 months of close.
“We are thrilled to join forces with Coherent to create one of the world's largest and most diverse photonics technology companies with leading positions in the growing market for photonics” - Alan Lowe, Lumentum President and CEO
Company Details: (Acquirer - Lumentum)
Lumentum (NASDAQ: LITE) is a major designer and manufacturer of innovative optical and photonic products enabling optical networking and laser applications worldwide. The products accelerate the speed and scale of cloud, networking, advanced manufacturing, and 3D sensing applications.
Founded in 2015 (Spin-off from JDSU), headquartered in San Jose, California, United States
CEO: Alan Lowe
Number of employees: 5,161
Market Cap: $7.50bn (as of 22/01/2021)
LTM Revenue: $1.60bn
LTM EBITDA: $470.90m
LTM EV/Revenue: 4.13x
LTM EV/EBITDA: 14.76x
Company Details: (Target - Coherent)
Coherent (NASDAQ: COHR) is a global company that manufactures and sells a variety of laser-based photonic products. The company’s products are used in manufacturing and instrumentation applications that include optical telecommunication, semiconductor manufacturing, inspection and test, advance packaging, and reprographics.
Founded in 1966, headquartered in Santa Clara, California, United States
CEO: Andy W. Mattes
Number of employees: 5,200
Market Cap: $5.02bn (as of 22/01/2021)
LTM Revenue: $1.23bn
LTM EBITDA: $100.73m
LTM EV/Revenue: 4.12x
LTM EV/EBITDA: 50.25x
Projections and Assumptions
There are significant benefits to Lumentum in the short run, strengthening best-in-class capabilities with an expanded product portfolio to best serve its customers whilst supporting long run expansion and R&D growth. The increased scale, flexibility and resources are set to boost Photonics revenue to $2.9bn as well as combining Lumentum’s $8.8bn addressable market in telecoms and LiDAR with Coherent’s $10.6bn addressable market in laser technology. This will create one of the world’s largest and most diverse photonics technology companies, with leading positions in the largest developing markets. Furthermore, through a combination of existing products and the results of combined R&D, Lumentum and Coherent believe the merged company will be able to play in 5G, advanced bioinstrumentation, advanced microelectronics, and consumer electronic devices, flat panel and OLED displays, communications equipment, electric and autonomous vehicles, and energy storage.
This deal also provides strong financial benefits in the short run. The combination will create a “best in class” financial model, with $150 million in annual run-rate synergies within 24 months after the close. The deal also is expected to be accretive to the combined company's non-GAAP earnings per share during the first full year and a solid balance sheet and strong operating cash flows will enable financial flexibility to pursue long term growth and R&D.
Lumentum’s move to acquire Coherent will bring key financial and strategic benefits for both parties. The first primary benefit is that this move will lead to the formation of a diversified industry leader through the merging of leadership positions across critical photonics markets. More specifically, this move combines Coherent’s cutting-edge photonic solutions across microelectronics, instrumentation, precision manufacturing, and aerospace defense markets with Lumentum’s world-class photonics solutions for the Telecom, 3D Sensing, and Datacom markets. The combined company will offer a diversified portfolio of photonics products and technology in growing end markets. This combined company will also accelerate Lumentum’s penetration of more than $10 billion market beyond 3D sensing applications and communications where Lumentum has traditionally held leadership.
The second primary benefit is that this merger will lead to a greater intersection of critical value chains that will be driven by long-term trends. Photonics will hold an increasingly important function in the shift towards digital approaches to daily life, professional life, healthcare, security, and even climate change. The merging of Coherent’s and Lumentum’s products will increase the intersection of value chains where photonics will be implemented to innovate in high precision manufacturing needed to create the high value goods that address these issues. The third primary benefit is that Lumentum’s acquisition of Coherent will put the combined company in an optimal position to pursue strong growth opportunities and new consumer markets while also expanding their leadership in Technology Stacks. The combined organisation will gain greater capabilities and resources, robust customer relationships, and a powerful combined R&D engine. Furthermore, the combined company’s increased vertical integration will enable an increased optimization of the combined company’s engagement in the technology stack of end market customers.
Risks and Uncertainties
Product positioning development will be an uncertainty in this acquisition. Undoubtedly, both Lumentum and Coherent are leading players in the photonics industry and the deal can enlarge the operating scale as well as the market share of the combined company. However, they specialise in different sub-market in the industry, with Lumentum’s core business in communications and 3D-sensing. These two areas are potential and expected to have a steady growth in future years under 5G development and further application of AR and AI in society. On a positive note, acquiring Coherent can diversify the product portfolio and reduce the operation risk of the combined company. Yet, since optical and laser manufacturing is capital-intensive and requires a high initial development cost, the shift of focus to a wider range of product mix may deteriorate the durable revenue growth in core areas. This may cause a slow down in revenue growth together with an increase in capital expenditure in the future periods.
Another risk regarding this deal comes from the balance sheet side of things. The current combined leverage that sits at 2.5 times will move up to 3.9 times, at least in the beginning. From an operational execution perspective, there are also doubts whether forecasted synergies can be realised as stated given that there were a number of businesses that Lumentum had exited or had revenue dyssynergies from the Oclaro deal was done in 2018. Lastly, some also worry that Lumentum is overpaying for the deal at 50% premium, signalling that the company might be punished through its stock price performance.
“The combination with Coherent is more of a “financial engineering project aimed at adding EPS at the expense of durable revenue growth” - Rosenblatt analyst (Ryan Koontz)