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II-VI: Technology for the Future (NASDAQ: IIIVI)

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As a materials science and optics company, II-VI (Nasdaq: IIVI) represents an excellent opportunity for organic growth in its core business, in addition to further growth from its recent acquisition of Coherent. After acquiring II-VI, it will become a global leader in optical and engineering materials, serving many high-growth markets such as 5G deployments, semiconductor manufacturing and precision manufacturing. II-VI’s share price fell significantly during the Coherent bidding war, giving investors the opportunity to buy the high-growth company at a discount.

Overview

II-VI operates two segments: Photonic Solutions and Compound Semiconductors. Historically, II-VI has primarily been a materials science company, but its acquisition of transceiver company Finisar in 2019 increased its photonic solutions business to around 66% of revenues, and its recent acquisition of Coherent adds another big element to the optics business. The segment includes his three business units: ROADM, Transceivers and Advanced Optics. These business units provide components for optical systems used in telecommunications, datacom networks, datacom hardware, industrial lasers and medical lasers, along with consumer products such as sensors, displays and projection equipment. I’m here.

The Compound Semiconductors segment develops components for semiconductor capital equipment, such as EUV lithography equipment and laser cutting of superhard materials, as well as the following specialty semiconductor materials: Silicon Carbide (SiC), Aluminum Oxide, Bismuth Telluride, Sulfide. zinc, zinc selenide, indium phosphide, and gallium arsenide. These materials are processed into wafers, processed, etched, and bonded to build semiconductors. Each type of semiconductor has a specific purpose and determines the type of material that must be used. Semiconductors are used in all electronic devices.

A small but significant part of II-VI’s specialty semiconductor materials is its SiC business. SiC substrate and wafer development is critical to the future of semiconductor manufacturing. SiC is a very difficult material to manufacture and takes considerably longer than manufacturing a normal Si wafer, but it offers higher voltages, a wider temperature range for which the semiconductor can be used, and faster switching speeds. and other advantages.

II-VI products serve a variety of end markets. Photonic Solutions’ products enable high-speed optical transmission and transport driven by the growing need for network bandwidth and the deployment of 5G networks. II-VI also operates in the industrial market developing components for precision manufacturing and laser cutting. Photonic solutions are also used in aerospace and defense products to enable military aircraft intelligence, surveillance, and reconnaissance devices.

The life sciences market requires II-VI solutions for biotechnology such as diagnostics, genome sequencing and imaging, as well as medical lasers. II-VI also manufactures optical products for smartphones, tablets, computer mice, and other consumer products. The most famous application is facial recognition on the iPhone. Finally, II-VI optics are increasingly being used in the automotive industry as sensors in driver assistance systems such as lane departure warning and blind spot detection.

On July 1, 2022, II-VI completed its acquisition of Coherent, an optical subsystem company. Coherent serves the microelectronics, precision manufacturing, instrumentation, aerospace and defense markets. Each of these businesses overlaps the markets II-VI currently serves, creating optical companies capable of creating both optical components and subsystems. Microelectronics refers to lasers used in semiconductor manufacturing and OLED, LCD and MicroLED displays.

Similarly, precision manufacturing consists of lasers used to manufacture automotive parts, medical devices, consumer goods, etc. at lower cost and with greater control. The instrument market refers not only to lasers for scientific research, but also to surgical lasers. Coherent products have served many purposes in aerospace and defense, including directed energy weapons, target designation, laser countermeasures, gyroscopes, and surveillance devices.

Strong Points

Combining II-VI and Coherent has created one of the largest companies in the optics industry. Composite business units operating in many of the same markets manufacture both components and subsystems, so they are well-positioned in each segment and offer opportunities for growth and expansion in other areas of the business should stimulate Examples include medical lasers, aerospace and defense, precision manufacturing, and sensing. As an integrated company with Coherent, II-VI can create almost any type of laser, laser subsystem, or laser component, giving us broad market reach.

New innovations are increasing the need for II-VI technology. Laser technology is growing rapidly and will continue to be used more as technology advances. The deployment of 5G networks relies on his II-VI for both optical communications and other precision manufacturing required to manufacture his 5G hardware. II-VI also plays a key role in the development of the Metaverse with optics and displays. They recently worked with Artilux to develop a 3D camera to improve the user experience within the metaverse. They’re also finding more ways to implant lasers in the automotive industry, using experimental technology to sense a person’s body position during a crash and deploy airbags to the most vulnerable spots on the person’s body.

Aftermarket sales of II-VI laser components are strong as they set a record in Q3 2022. Aftermarket sales were not disclosed, but Giovanni Barbarossa, chief strategy officer, explained that this, combined with record global sales in March, showed high utilization of lasers, adding that “industrial activity It is a good substitute for the whole.” End users are increasingly choosing II-VI laser technology for its unmatched accuracy and efficiency.

The future of SiC in the semiconductor industry is bright. II-VI believes this, and he plans a $1 billion capital investment to improve and scale SiC manufacturing. SiC provides better wafers than Si substrates because it is faster than Si, can deliver higher voltages, and can withstand temperature changes. We need to be more competitive in the SiC market by enhancing our manufacturing processes for products that are notoriously difficult to manufacture.

II-VI has proven adept at integrating new acquisitions. Since 2010, II-VI has completed five transformational acquisitions across business units. Before Coherent, II-VI’s largest acquisition was Finisar, which closed in 2019. II-VI was able to grow Finisar’s transceiver business into his II-VI’s large, high-margin offering. Acquisition of Finisar increased Photonic Solutions revenue by 140.54% from 2019 to 2020. The Coherent acquisition is expected to increase current revenues by approximately 50%. The acquisition has integration risks, including the possibility that II-VI overpaid his Coherent, miscalculated synergies, management reorganization, and effective mergers of groups such as R&D. An acquisition of this magnitude, however, could be transformative if executed well. II-VI will gain significant scale advantages in research and development, sales and marketing, and manufacturing.

II-VI is currently undervalued relative to its peers. II-VI’s closest peers include IPG Photonics (IPGP), Lumentum (LITE), and ON Semiconductor Corporation (ON). During the acquisition of Coherent, II-VI experienced a decline in valuation due to the aforementioned integration risks, creating a buying opportunity for investors. The II-VI forward P/E is currently 12.00, while IPG Photonics is 22.39, Lumentum is 13.59 and ON Semiconductor is 13.83.

II-VI also discounted the price/sales, price/book, and price/cash flow ratings, which are 1.74, 1.77, and 8.07, respectively. According to Zack’s Research, IPG Photonics has valuations of 3.54, 2.07 and 15.16, Lumentum has valuations of 3.87, 3.40 and 11.19, and ON Semiconductor has valuations of 4.05, 5.70 and 16.10 respectively. II-VI is rated below the S&P 500 average, while its competitors are rated close to or above average in most categories.

Cons

II-VI is experiencing cyclicality in some business units. Our consumer business is seasonal because our largest customer is Apple (AAPL). As management believes, the semiconductor business has a multi-year demand cycle for semiconductor capital equipment. The cyclicality of semiconductors is more of a concern as he is one of his two business segments accounting for 34.4% of his 2021 revenue.

The laser technology market relies on the development or acquisition of new technologies. II-VI risks new competitors developing new technologies and current competitors competing for more market share. To continue our impressive growth, we need to be on the cutting edge of new technologies and laser applications.

II-VI has significant exposure to China through its semiconductor division. About 75% of the world’s semiconductors come from China, so II-VI faces supply chain struggles due to China’s COVID lockdown, as well as political and trade tensions. Unless semiconductor manufacturing moves to more countries, there is no way around this II-VI problem. This is due to the recent semiconductor shortage, as evidenced by a 5.5% decline in compound semiconductor revenues in Q3 2021 compared to 31.5% growth for the segment in Q3 2021, resulting in II- constraining the growth of VI’s semiconductor business.

II-VI is an incredibly complex company. Their technology and products are not easily understood without significant research. This can lead to limited analyst coverage, a lack of retail investors, and potentially undervalued valuations compared to companies with similar growth characteristics and opportunities.

Conclusion

With the acquisition of Coherent, II-VI is now a world leader in laser technology, optical technology and processed materials. II-VI has strong competitors in every business unit, but he has become one of the leading players in high-growth industries. Long-term growth potential is strong as applications in optics, lasers and semiconductors become more closely linked to our daily lives. Optical communications, aerospace and defense, medical lasers, manufacturing, sensing, and SiC all offer significant avenues for growth as new products continue to employ his II-VI technology.

For example, in the automotive industry, almost all new vehicles use laser technology in the form of driver assistance systems. II-VI has expanded rapidly over the past 11 years, growing revenue from $503 million to $2.4 billion, adding 16 new major products and completing multiple acquisitions. Through this growth, they have demonstrated that they are up to the challenge of developing new technologies or acquiring and integrating them to stay ahead of their competitors.

II-VI’s share price has fallen more than 45% since it first proposed the acquisition of Coherent in February 2021, and it’s doing poorly. During this same period, the S&P 500 has risen about 7%. The decline in market value appears to be due to concerns that II-VI overpaid for his Coherent as it was in a bidding war with competing Lumentum. The price slump also reflects II-VI’s concerns over its ability to successfully integrate Coherent, as well as taking on additional debt to finance the acquisition. Although there are significant risks associated with the Coherent integration, II-VI’s competitive valuation relative to peers, track record of successful acquisition executions, and leading position in high-growth industries make II-VI attractive I think it will be a good investment. Recommended purchase for long-term investors.