Getting the measure of Viavi
Two years ago, JDSU spun out its optical components business as a separate entity. The piece that remained, which incorporated test instrumentation and optical security, was christened Viavi Solutions. The logic was that the different parts of the business – test instrumentation and optical modules – had different requirements and different trajectories, and would be better served by going their separate ways.
The move represents a significant departure from the thinking that created JDSU in the first place; the company rose to prominence as one of the most acquisitive players of the dot-com boom, vacuuming up start-ups and established players alike.
JDSU became a force in test and measurement when the company acquired Acterna, then the number two in the market, for $760 million in August 2005. Further acquisitions expanded the company’s test portfolio; it bought Agilent's wireless network test business for $165 million in May 2010, and Network Instruments, a provider of performance monitoring instrumentation for enterprises and cloud companies, for $200 million in January 2014.
Past performance is no guarantee of future success, however; especially in a turbulent industry like telecom. In addition, Viavi has faced unique challenges of its own. Not only did the firm change its name; two weeks after the spin-out, CEO Thomas Waechter, who had led JDSU since 2009, stepped down to pursue other interests. Following an executive search Oleg Khaykin, a semiconductor industry veteran, took the helm.
Khaykin was doing some work part-time with private equity firm Silver Lake Partners when he was approached by the executive search firm in November of 2015. ‘For the past 15 years I was primarily involved in the semiconductor industry and companies like JDSU were my customers rather than my peers,’ he recalled. ‘But I thought sure, I’ll take a look.’
Khaykin was soon convinced that joining Viavi would be the right move. ‘When I look at a technology company, my first question is how good is their technology? Because in the tech space if you are mediocre then there’s not much you can do. After doing my due diligence I was very satisfied that in the markets that they play, Viavi has the best technology in the world,’ he declared.
‘On top of it the company had a balance sheet that was in fairly good shape. More importantly it had significant NOL reserves, which is net operating loss. If you remember back in the days of JDS Uniphase, it made significant acquisitions and many of them were written off. So as a result, the company has big tax loss reserves that, if you start making money, work very nicely for you.
‘But the company in terms of its plumbing and its processes was not performing as well as it should. I said that is one piece I can fix within the relatively near term and then we’ll set our way to scale up the business and reveal strong competitive position in the market. What attracted me is the opportunity – not what the company was, but what it could become.’
Like others in the industry, Khaykin was surprised by the decision to choose a new name. ‘I tell you I had a shock,’ he said. ‘Why in the world would you take a name like JDS Uniphase that everybody knew and pick another name? But I came in and the name was already changed, and it grows on you.’
‘Would I do it differently?’ he mused. ‘I don’t know. I was not here when the decision was made. My job is to make Viavi a great brand name, and the way you make a great brand name in this industry – we’re not in the consumer space – is technological innovation. In a few years nobody will remember that there was a different name at one time.’
Viavi’s operations had become overly complex; an experienced hand and a fresh perspective were needed to put the business in order. ‘JDSU was a very acquisitive company. What they did not do a good job of is integrating those businesses into common processes and common platforms,’ he said. ‘As a result, it’s become a patchwork of lots of operations … effectively they ended up with a combination of lots of little companies and a common sales force that was tasked to sell everything.’
There was a time when JDSU positioned itself as a ‘one stop shop’, but that strategy is almost impossible to execute. ‘Everyone who has tried it has failed miserably,’ Khaykin observed. ‘In many cases where JDS had a very strong position, they took eye off the ball. It’s a common trap that companies fall into. My view is that if you have a strong business that is your market leader, your first strategy – and your second and third – is to protect your market leadership. Once you have that firmly under control, then you can start looking selectively at where you want to grow.’
He continued: ‘The first thing I did was, when I came in, was secure the base. We looked at our core business where we are a strong market player, we made sure we refocused on it and stopped the forced attrition to fund businesses that had no established position. Second, I looked at all the so-called growth initiatives which were not growing, and were consuming a significant amount of cash.
The firm had to cut back. ‘We decided that we were being too ambitious. We were trying to compete in every single software segment in the telecom industry where we went up against players who are several orders of magnitude bigger than us and they’re not going to just roll over. So, we’ve significantly scaled back that part of the business, reducing cost, and diverting some of these reductions as investments into the core business.’
But Viavi did not exit software completely. ‘We decided to make sure that where we do play in software, it is tied to our position in instrumentation and reinforces and acts very synergistically with our instrumentation, and at the same time, positions us well for the industry trends towards a greater degree of virtualisation and automation of the customer network,’ he explained.
Disruption and opportunity
Viavi’s core business is selling to telecom and cable operators, but that environment is changing. First, the telecom industry has become quite mature, which alters customer purchasing behaviour. ‘What drives volumes of sales is the build out and expansion, but in most countries, the [telecom] build-out is over. Some of this is still going on in China, so there are some opportunities there, but by and large in North America and Europe, most service providers are in a maintenance and optimisation mode. That requires fewer instruments.’
Second, operators are consolidating. For instance, AT&T is buying Time Warner Media, and Charter bought Time Warner Cable. ‘When [our customers] combine the first thing they do is combine network operations, field teams and so on, and a lot of decisions on upgrading and replacing their test and measurement equipment get delayed until they figure out their new structure. So that reduces the size of the market,’ he explained.
At the same time, technologies continue to evolve at what seems like an accelerated pace. ‘It’s still just as much work needed to bring out new technologies, but now you have a smaller number of units over which you have to amortise it. Pricing cannot really move that much, so that puts significant price pressure on the product,’ Khaykin said.
The third element is the emergence of virtualised testing models to replace traditional application-specific hardware. ‘This is a big disruptor for our current environment,’ he noted. ‘The big question then comes in how you price it. You need to price it in such a way that the operating profit that you generate from these licensing models is more than adequate to cover your engineering expenses.’
However, where there is disruption there is also opportunity. While some markets are declining, others such as hyperscale data centres are growing rapidly. ‘This whole web 2.0 scenario – Facebook, Google, Microsoft, Alibaba, Baidu – presents significant opportunities for us in terms of traditional test and measurement equipment, but you need to modify your product and your go-to-market strategy to take advantage of that,’ he said.
Enterprise data centres also represent an expanding market. ‘We are seeing significant interest in fibre taking our expertise downstream. What used to be data centres with a lot of Ethernet-based copper is all going to fibre. And it introduces a whole new segment, which is for us to take our traditional fibre expertise that we gained with service providers and equipment manufacturers, and bring it into the data centre world of servicing and maintenance.’
Viavi is also taking its skill set into new areas as optical fibre enters new markets. ‘We see [optical fibre] moving closer and closer to the edge, in the consumer space in the home, building, and in the service provider’s case all the way to the antenna. Now that the fibre is going all the way to the antenna, it presents us with unique opportunities to develop hybrid instruments – when you have a technician going to a cell tower they only need one instrument so they can do both fibre and RF optimisation for the tower.’
Protecting product development
This means Viavi has a broad product portfolio, stretching all the way from the home to the core of the network. In terms of speeds and protocols, the firm has to stay abreast of developments in gigabit-capable G.fast for copper networks, through DOCSIS 3.1 in hybrid-fibre coaxial networks, to 400G optical transmission in core networks, and the plethora of emerging optical protocols for data centres, to mention just a few.
‘We have to spend a lot on R&D,’ Khaykin commented. ‘Clearly, on the research piece, we want to be the first to market with all the innovation in standards and new technologies, but at the same time we need to become much more efficient in our R&D. That’s leading us to take a much deeper look at how we develop products.’
Viavi’s product development is now based around fewer platforms that support multiple applications. ‘For example, before we made 80 different products and we had 80 different platforms because we had one perfectly tailored for each sub-segment of the market. Today we’re trying to do it with three to four general platforms with interfaces and software being used for customisation for each of the different segments,’ he explained.
The company is also ‘working smarter’ by considering future data rates at an earlier stage. Every development for high-performance lab equipment is already tagged on the firm’s roadmap for mid-range products. For example, when Viavi makes an instrument for the lab at 400G, it knows that within two years, it will need the exact same capability in its metro and in data centre products.
Close ties with suppliers and customers are also vital when working at the cutting edge of technology. ‘I think terabit is the next stop,’ said Khaykin. ‘It’s a very symbiotic relationship to [develop a] terabit tester when nobody can make the components for it, right?’ The test instrumentation company sits between the service provider and the component manufacturers; vendors must work together to take the technology forward.
Scope and scale
With such a broad product range and a broad customer base, Viavi’s sales force has a formidable task. ‘One of the things that really struck me coming into this industry is how fragmented the go-to-market environment is,’ Khaykin observed. ‘In the semiconductor industry, you have tens of thousands of customers; but you also have a mass of global distributors who can reach all those customers in a very cost-effective manner, so as a company you only need to focus on your top 50 customers. In a place like Viavi you have to go practically direct to most of your customers. There are a lot of telecom companies, but there are no regional or global distributors for our type of products, so in that respect the sales cost is the biggest single component of the cost structure. So, there is significant operating leverage you get from merging with companies within your current market.’
Another wave of mergers and acquisitions is inevitable, he believes. ‘It’s only natural because the customer base has been consolidating, but there hasn’t been much merger and combination of the equipment vendors, or the test and measurement providers in this space. You see this happen everywhere else. … eventually pure economics will drive people to consolidate.’
Viavi’s perfect partner would be one that helps it grow in terms of operational scale. ‘We probably have more technologies than we need, what we need is scale,’ Khaykin said. ‘That means acquiring companies that play in our space. Of course, to the extent that they have technologies that complement ours, we can create a best-of-breed company that is more operationally effective.’
For now, however, Viavi’s priority is to get its own house in order. ‘If you do make an acquisition, how do you drive integration if you don’t have good robust processes? Things will just become that much more complex. Our perspective is first get our own house in order, get it performing right. We’ve made significant progress with that.’
Some of the early changes are starting to bear fruit. ‘Fiscal 2017 was my first full year as the CEO at Viavi, and the stock price has doubled since I came on board,’ he said. ‘I am pleased with the many transformational changes we’ve initiated and the progress to date. My team has completed a focused restructuring of the software business, and the company has begun a necessary industry consolidation by acquiring broadband test instrument vendor Trilithic.’
Trilithic, located a couple of miles away from Viavi’s design centre in Indianapolis, sells broadband instruments for home installers. With annual revenues in the region of $20 million, its products compliments Viavi’s high-end, complex test instruments for network technicians and will help the company expand outside North America. The deal closed on 9 August.
In the next year or two Khaykin hopes Viavi will see even greater benefits. ‘I will reserve my personal satisfaction until I see real results,’ he said. ‘But clearly our investors and many of our customers have recognised that the company is now looking very different as a much more aggressive, more focused organisation. Now we just need to execute on all our plans.’