More Fear And Uncertainty Around II-VI Isn't So Bad For Long-Term Investors

 I’ve said this many times in the past, but it bears repeating – while “buying the dip” is an often a good-to-great long-term strategy with good companies, it’s not always easy to do it. The markets surely do freak out from time to time and offer up seeming bargains, but most often a “buy the dip” opportunity comes about because there are real concerns in the market about the short-term prospects for the company in question. 

That brings me to II-VI (IIVI). I didn’t like the core fundamental valuation on the shares back in February, though I was still bullish on the long-term prospects for this leading (if complicated) optical and materials technology company. With the shares down about 25% since then on fears that the company is overpaying for Coherent (COHR), not to mention worries about near-term end-market demand and an overall cooling on expensive growth, the shares look a lot more interesting for long-term investors today.

 

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More Fear And Uncertainty Around II-VI Isn't So Bad For Long-Term Investors

II-VI Dives Into The Battle For Coherent And More Diversification

Coherent (COHR) has suddenly become hot property, with three companies bidding on this photonics, laser, and optical components company. The latest entrant, II-VI (IIVI), would appear to be seeking to not only round out some of its assets in photonics, but also further vertically integrate its laser and optics capabilities, as well as expand its addressable market opportunities outside of communications.

The $6.5B price that II-VI is offering is indeed steep (or closer to $6.8B including a break-up fee), but II-VI’s $200M synergy target may well prove conservative and II-VI has a good history where deal integration is concerned. What’s more, there’s legitimate scarcity value here, and II-VI won’t really have another opportunity at an asset like this.

The Coherent deal isn’t a “must have” for II-VI, and the added debt will be an issue for some investors, but I believe it makes long-term strategic sense. My bigger issue with II-VI is the valuation, as II-VI has definitely transited to “growth stock” valuation over the past six months or so. Granted, with II-VI’s leverage to telecom and datacom infrastructure spending, 3D sensing growth, silicon carbide growth, and other drivers, it deserves to be treated like a growth stock, but the valuation isn’t as straightforward as before.

 

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II-VI Dives Into The Battle For Coherent And More Diversification

II-VI Seeing Expanding Opportunities And Shrinking Valuations On Optical Sector Worries

If anything, the investment case for II-VI (IIVI) is more compelling now than it was in late May, even though the share price is almost 20% lower now on market worries about the health of the optical space. Ciena (CIEN) spooked the market with commentary calling for weaker near-term Tier 1 metro equipment spending, and investors are also now more concerned about a possible slowdown in data center spending, as well as the potential ramification of U.S. actions to limit the access of Chinese companies to various components and technology.

For II-VI, though, the company is starting to see a ramp in 3D sensing and opportunities in markets like 5G and 400G data center are still in the near future (as is sensing, really). On top of that, a few small acquisitions and a licensing agreement with General Electric (GE) have quickly moved II-VI from a "picks and shovels" supplier of silicon carbide (or SiC) wafers to a potential player in chips/devices. Given a strong growth outlook in multiple markets and today's valuation, I think there's a credible case for a double-digit expected annualized return from today's price.

 

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II-VI Seeing Expanding Opportunities And Shrinking Valuations On Optical Sector Worries

II-VI Looking To Flex Newly-Bought Muscle In Multiple Growth Markets

I wouldn't expect a stock that was up more than 40% over the past year and serving growth end-markets like data centers and 5G infrastructure to be undervalued, but that may yet be the case with II-VI (IIVI). There's an above-average risk here, as a lot of II-VI's value is predicated on grabbing share in markets like 3D-sensing, leveraging capabilities in advanced materials like SiC, and generating healthy margins in markets like optical components where that has historically been hard to do, but those risks seem more than balanced by the opportunity.

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II-VI Looking To Flex Newly-Bought Muscle In Multiple Growth Markets

Seeking Alpha: IPG Photonics Looking To Innovation And Integration

It's still pretty tough out there if you're in the laser business. While Newport (NEWP) and II-VI (IIVI) have come alive in the last three months and Coherent (COHR) and Rofin-Sinar (RSTI) are both in the green for the full year, only Newport has kept pace with the S&P 500. Even so, IPG Photonics (IPGP) has done even worse, as wobbly quarterly performance and weak end markets like industrial welding and automotive have discouraged investors in this volatile laser company.

Still, I think there are better days ahead for this leading fiber laser company. Fiber lasers continue to gain share in the growing laser market, and the number of applications for fiber lasers has only been increasing. Not only does IPG Photonics enjoy a strong IP position and a good reputation for innovation, but the company's vertical integration allows it to produce lasers at considerably lower costs than its rivals - leaving the company free to compete on features when it can, and price when it must.

On a cash flow basis, I believe these shares are about 25% undervalued today, and I do expect rather aggressive adoption and growth for the company over the next five and ten years. EV/EBITDA also supports the notion that these shares are undervalued, and though global industrial capex spending remains a major unknown, I believe the success of IPG Photonics is more weighted toward "when" than "if".

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IPG Photonics Looking To Innovation And Integration

Seeking Alpha: Investors Are Already Pricing In Lincoln Electric's Recovery

Every once in a while shares of the world's largest welding company, Lincoln Electric (LECO), sell off and get cheap. These opportunities seem to come about every two years or so, and investors would do well to look out for them, as there are plenty of people who know all too well just how good of a company this is. Accordingly, while Lincoln Electric had pretty weak results within the welding industry, the market has not only shrugged it off but pushed these shares to a new all-time high.

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Investors Are Already Pricing In Lincoln Electric's Recovery

Seeking Alpha: Is This A Chance To Pick Up II-VI For The Rebound?

Sometimes one of the best things an investor can do is pick up shares of a quality company on a temporary problem in the industry. For instance, investors who bought Lincoln Electric (LECO) below $40 are probably pretty happy that they did so. While the shares of laser optics and components maker II-VI (IIVI) have been volatile, they historically haven't stayed very cheap for very long. The question for investors now, though, is whether this is another buying opportunity or whether II-VI's addressable markets have changed in fundamental ways that will make this a disappointing stock from now on.

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Is This A Chance To Pick Up II-VI For The Rebound?

Investopedia: II-VI Still Taking Five

II-VI (Nasdaq:IIVI) is one of those quality small caps that tends to stay under the radar. There's not much sell-side coverage, and frankly not much institutional ownership by the standards of this market. While II-VI still has yet to recover from the Thai floods that disrupted business, the company's strong share in various laser optics markets makes it one worth watching.

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Danaher Assimilates Another Company

Scarcely any organization outside of Star Trek's Borg have taken the route of growth-by-acquisition quite like Danaher (NYSE:DHR). Fortunately, Danaher is quite a bit friendlier in its approach and typically makes very fair offers to the shareholders of the targeted company. They are at it once again, though, announcing on Wednesday that they would acquire electronic test equipment specialist Keithley Instruments (NYSE:KEI) for $21.60 in cash.  

What Danaher Is Getting?
In paying a net value of about $300 million, Danaher is acquiring a leading niche electronics company with trailing revenue of over $100 million. That is a pretty good premium for Keithley shareholders, at least relative to the current valuation of others in the "scientific equipment" space like Agilent (NYSE:A). Although some shareholders may lament that the company sold itself just as business seemed to be recovering, Danaher is giving them an exit price that has not been seen since 2004. It is entirely possible that Keithley might have had another run in it, but Danaher is offering a risk-free price that should satisfy almost any shareholder. 


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