Inside a Merger that Worked – Oclaro

Posted on November 14, 2010

Two companies merge to gain economies of scale and to create an industry leader. How many times have we heard this story only to be disappointed by the results? Where 2+2 equaled 3?

But not so with Oclaro (NASDAQ: OCLR), formed when CEO Alain Couder merged $300M Bookham (NASDAQ:BKHM) with $200M Avanex (NASDAQ: AVNX) in April of 2009. Today, the combined company’s stock price is up nearly four times from April of last year. Adjusted EBITDA is at 10.5%, growth is at 35% and the company is focused on a goal of hitting the $1 billion revenue mark within two years. So what did Alain and his executive team do differently to make this merger work so well?

As always, it starts with strategy. The optical components industry (think fiber optic transmission of data) has long suffered from over-fragmentation, with most players struggling for profitability over the past ten years. This created an industry-wide culture of adversity and of feeling “beaten.” The business is capital intensive; all significant players own fabs (optical integrated circuit and laser fabrication factories) and require heavy R&D spend to keep up with the pace of technology.

The fundamental question, long before any M&A activity starts, is what will/should the company look like in three to five years to optimally exploit the market opportunity? Should it be bigger? Should it own more of the underlying technology? Should its R&D and new products be contributing to a bigger share of future revenues? Should its distribution/channel strategy be fundamentally different? Should the firm vertically integrate?

When Alain took the helm of Bookham in August of 2007, it was bleeding cash. Strategically, the company needed scale and product breadth to prosper. He began planting the seeds for a Bookham-Avanex merger.

By January 2009 the deal became public. Both parties had already agreed on the messaging, and key executives from both sides were committed to the company. As they worked to close the deal, the groundwork for the integration was quietly built. The new company would have a fresh start with a new name, rather than have one “losing team” whose company name was dumped. The management team and the board would be selected from the best of both companies through a transparent process. And the company values would be inviolate: respectful, ready to help, and inventive.

All this advanced preparation could have been a big waste of time if the deal had not been approved. Surely, all the executives were really busy with their “day jobs” even before all of this merger preparation. But integration planning is too complex and takes too long to start after the deal closes. Investing time and energy early and heavily – knowing the risk of the deal falling through – is one of the fundamental requirements to make an integration work well. Rushing to close a deal might seem like a good idea to minimize the uncertainty that every passing week can bring.

But the goal, frankly, is not closing the deal. The goal is having a deal deliver on its economic promise, and that requires the kind of serious pre-close integration planning that Alain and his executive team did. Better to have a deal blow up just before a delayed close than to have it fail or grossly underperform in the integration phase. (Do realize that this perspective will give your investment banker heartburn. Most of them really just want to close the deal.)

Before the deal closed, Alain and his team put together and clarified four strategic pillars that support the success of the new company.

• Ease of Doing Business. They were determined to be an easy company to do business with. No high barriers; no tiresome processes for customers to navigate.
• Innovation. They had to have products that truly fulfilled the need of the customers, and they had to out–innovate the competition on a regular basis, and apply innovation at every level and in every function of the company.
• Architectural Clairvoyance. Oclaro needed to know the direction of the industry in advance, so that the right platforms and products could be built, with enough time to build them well.
• Integration. They knew that they had to focus on the tactical issues that integrating two companies always requires, but that often get short-shrift. One of the key tenets of the integration was that it would have zero impact on customers. In addition, Oclaro now had all the major building blocks from chips to sub-systems. This vertical integration would allow Oclaro to innovate at every level – with world class photonic integration capabilities bringing multiple lasers onto a single die; to innovation in modules and subsystems that give customers a faster time to market. In addition, having the system-level expertise meant that Oclaro could be first to market with chip level innovation as well – and across every component of the system.

Careful planning and work was put into a communication plan for the announcement day and the months that followed. It was decided that every employee would know their fate on the first day of the new company so that decisions could be made ahead of time – and they were. Imagine the planning and execution requirements for this one task alone, given 15 locations and about 2,600 employees. But it was accomplished.

Few things are as distracting and disconcerting to employees as M&A. Employees will burn up hours by the dozen wondering what will happen to them. They lose motivation thinking that their work is for naught. Once they know they have a job going forward (if they believe it) they can then become confused about new methods and ideas coming in from the other company. In my own M&A experience as an acquiring CEO, I was always amazed at how throughput dropped for a long time as people adapted and memorized new part numbers, new customers, and new processes. Communication and training, often over and over again, are two of the best tools for creating a smooth integration.

Communicating to employees was not all that was needed. Even though the combined company was a tier one supplier and #2 in the industry, it was only approaching a 30% market share. Oclaro had to reassure customers that everything would be fine to stave off the competitive attacks that would (and did) come. In the month after the announcement, Alain visited every one of the company’s facilities as well as all the key customers personally. Likening himself to a broken record, he repeated and repeated the four key strategic pillars and the company values.

In short order, costs were reduced by over 7%, as a percentage of revenues at the time, partly by in-sourcing key components which led to better fab utilization. With a rationalized cost base, Oclaro was able to fully fund R&D to execute on its architectural clairvoyance, resulting in more innovation. Most importantly, the profits and cash flow from a bigger, more efficient company meant that the culture shifted from “survival” to a “thrive” mindset, where the team believed they could win and could be the clear leader in their sector. Alain says, “You don’t succeed using the whip. You succeed with a vision that excites.” The winner’s attitude prevailed, and Oclaro began planning for and working toward success, rather than survival.

Today Oclaro is hiring as fast as it can find talented people; the challenge is keeping up with orders. The company just raised $77 million in a secondary offering. The team, just five months after.