With Friends Like Nortel ...

Mar 12 2001

Not long ago, JDS Uniphase was a Wall Street darling, riding soaring demand for optical networking components. The stock, which peaked last spring at about $150 a share, seemed to be the next Cisco , with a market cap well north of $100 billion. In February, JDS acquired its biggest rival, SDL - a move that should have caused JDS investors to celebrate. Instead, they've been bailing out.

Since the close of the SDL deal, JDS shares have lost about two-thirds of their value. Last week, the firm said it would lay off 3,000 employees, about 10 percent of its staff.

What went wrong? It may have been something about a messy agreement to sell a Zurich-based factory. Federal regulators required the sale of the plant as a condition for approval of the SDL deal. Luckily, Nortel Networks offered to buy the plant for $3 billion in Nortel stock. Or at least stock that used to be worth $3 billion. With Nortel's stock in free fall in recent weeks, JDS' stake is now worth $1.2 billion. Mark Langley, a senior telecom analyst for Epoch Partners, says the lowball value of the plant is about $3 billion.

Given that the deal closed just weeks before Nortel issued a shocking earnings warning, you might wonder if JDS is considering litigation. The answer is no; rather than sue Nortel, JDS is trying to negotiate a solution. One reason for the careful stance: Nortel is JDS' biggest customer, responsible for at least 10 percent of JDS' revenues. Both companies are downplaying the situation. "The deal is closed and no one was jerked around," a Nortel spokesman says. "We are trying to get over it and move on," says a JDS Uniphase representative.

The key question is whether Nortel withheld information about its deteriorating financial position. While rivals Cisco and Lucent previously disclosed earnings concerns, Nortel CEO John Roth repeatedly reassured investors that everything at his company was on track. Oops. On Feb. 16, Nortel said earnings this year would fall far short of expectations. Nortel shares crumbled by a third on that day and have been limping ever since.

Shareholders may wonder if Nortel withheld information in an effort to get the plant from JDS at a bargain price. Some analysts give Nortel the benefit of the doubt. "I don't think they behaved unethically," says Tom Astle, a Merrill Lynch analyst.

But there may be other trouble ahead. Astle thinks Nortel won't meet the 15 percent revenue growth it predicts for the year. And that's bad news for JDS, too. Not only is the firm a major supplier to Nortel - now it's a major shareholder as well.