Marvell's deal for Lumentum is giving flashbacks to the dot-com bubble

By Emily Bary

Newly announced $115 billion deal for Lumentum will be financed entirely through stock: 'There's a real echo of 2000 here'

Marvell plans to buy Lumentum in an all-stock deal.

Marvell Technology officially plans to combine with Lumentum Holdings in a massive all-stock deal meant to target the optical-networking market - and one that's giving some experts a feeling of déjà vu.

Optical technologies have become key to moving artificial-intelligence data at high speeds. Marvell (MRVL) and Lumentum (LITE) see the deal as a way to more quickly address this booming market, which they say could be worth $550 billion.

"AI infrastructure is undergoing a fundamental architectural shift toward optical connectivity, creating an opportunity that comes along once in a generation," Marvell CEO Matt Murphy said in a Monday morning release that announced the deal agreement.

But some experts are getting flashbacks to an earlier generation - and the sorts of all-stock deals that became emblematic of the dot-com boom and bust.

"People who went through this would say, 'I have seen this movie before,'" Feng Gu, an accounting professor at the University of Buffalo, told MarketWatch last week after reports of the Marvell-Lumentum deal began surfacing.

See also: All the reasons Marvell investors are 'freaking out' as Lumentum deal rumors swirl

In the late 1990s and early 2000s, companies with soaring stock prices tried to use them to their advantage, buying up other businesses and paying for the deals with their expensive shares.

One of the most notable examples was the merger of JDS Fitel and Uniphase in 1999, positioned as the creation of a fiber-optics empire. While the two businesses had complementary assets, Uniphase prohibitively overpaid for JDS Fitel, financing the deal with its own pricey stock before going on to make other expensive acquisitions in the same manner. When the dot-com bubble burst, shareholders ended up with diluted ownership stakes in businesses that had lost significant market value.

"There's a real echo of 2000 here," said Anup Srivastava, an accounting professor at the Haskayne School of Business at the University of Calgary.

Marvell and Lumentum didn't immediately respond to MarketWatch's request for comment on the all-stock nature of the deal.

Using stock like a valuable currency

The parallels are interesting for those who know Lumentum's history. JDS Uniphase eventually unwound in a 2015 separation that left behind two businesses: Viavi Solutions, a maker of testing and monitoring equipment for networks, and Lumentum.

In other words, "Lumentum is JDSU's direct descendant," Srivastava told MarketWatch last week.

When it comes to the newly announced Marvell-Lumentum deal, the "strategic logic is real," according to Srivastava. "Broadcom sells the whole optical system," he explained. "Marvell sells pieces. Lumentum fills the biggest gap."

In that sense, the deal "is partly insurance for Marvell," something that could help it avoid "slowly losing ground as the technology shifts," he said.

But the question turns on the deal's financing. Marvell had a $172 billion market capitalization as of Friday's close, and the company had $1.6 billion in net debt on its balance sheet as of the last quarter, according to FactSet.

The deal assigns a $115 billion implied enterprise value to Lumentum, given that Marvell is offering a 24% premium to Lumentum's closing price as of Oct. 28, before Bloomberg News reported on the deal talks.

Having roughly doubled in price this year, Marvell shares now trade at about 65 times trailing estimates for earnings per share, according to FactSet. Gu noted that at the peak of the dot-com bubble, JDSU had a price-to-earnings multiple well above 100 times earnings, and sometimes approaching 200 times earnings.

All-stock deals let companies use their soaring shares to their advantage. On the surface, "this sounds like a smart strategy," said Gu, because companies can treat their richly valued shares as an opportunity "to acquire some real assets."

But the strategy can also create problems. For one, management teams can overpay for businesses when they're using their stock as currency, said Gu, whose research has examined the history of these transactions. Companies also have to deal with the challenges of integration, spending money to fuse the businesses in ways that will allow them to achieve the stated benefits of the merger.

And if the stock price goes down, whoever owns the stock - whether that's employees or investors - could become dissatisfied, he added.

It takes time for such deals to close, as well. Marvell and Lumentum expect their transaction, which is subject to approval by shareholders and regulators, to be completed in the first half of 2028.

Market conditions can change rapidly in the time it takes deals to reach completion. "JDSU used its soaring stock to buy SDL for about $40 billion," said Srivastava. "By closing, that deal was worth about $13 billion. A year later, JDSU posted a $50 billion loss."

Gu says that deals financed with expensive stock can be a problem for investors in the company that's issuing shares to facilitate the transaction, in this case Marvell. That's because the acquiring company has a tendency to overpay, whereas shareholders in the target company - in this case Lumentum - get paid a premium through the acquisition and may be able to cash in on that if they don't plan to hold on to the stock over the long term.

Marvell shareholders will own about two-thirds of the combined business once the deal is closed.

But Srivastava sees things differently, saying that it can be "fine" for companies to finance acquisitions though expensive stock, especially when the alternative is paying for these deals in cash or with borrowed money.

"If Marvell pays with its own richly valued stock, it's trading expensive paper for expensive paper," he said. "That's not necessarily bad for Marvell. The risk shifts to Lumentum holders, who will get Marvell's paper and will be betting that the stock holds up."

-Emily Bary

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