A recent blog article on Light Reading gets into whether the initial backlash on the Street against Ciena was justified based on the past quarterly results as well as on the projected performance of the vendor. In our opinion, and as we have discussed in the past, despite rather exemplary leadership on the technology portion of the company over the years, it has been held hostage for a very long time by management on the financial and marketing sides of the business with a shockingly insufficient amount of intimacy with the optical industry. We also believe that there is a serious tone-deafness when it comes to its interactions with the investment community, such as in inadequately addressing the “severe deceleration in growth rate” in its core business over about the last four years on the past earnings call. Finally, there are the “rookie” kinds of mistakes regarding strategic decision-making that have not been addressed.
Concerning the last point, our intelligence indicates that Ciena had taken itself out of the running indefinitely at one of the biggest, high-end buyers of Data Center Interconnect (DCI) equipment because it terminated the N-Series hyperscale program from Cyan (the acquisition was closed in August). This potential customer was pretty much committed to purchasing the platform because it had the desired density and form factor at the 100G data rate. (Ciena’s current Waveserver is not comparable right now.)
In effect, Ciena's statement to Lightwave in the summer was evidently correct concerning the future of the N-Series: "We are committed to meeting the needs of existing customer bases...." That major data center operator would have apparently been the first purchaser.
In addition, we question Ciena’s judgment, especially as a dominant transport vendor, in agreeing to provide just “piece-parts” for an Open Line System (OLS) to at least one other large data center operator. (Actually, we wonder if “indirect sales” to the DCI space is code for OLS at the firm.) It not only potentially facilitates an even greater amount of interest not just by other DCI purchasers, but also possibly leads to demands for OLS in the public network.
There may certainly turn out to be cost advantages across Ciena’s optical product line as a result of an incremental investment in a DCI product. However, the adoption of the OLS approach, especially in terms of operating at 100G, is presently a worse situation than being in the components space in general in that there appears there may be only a single other customer available for Ciena – because one of them is apparently no longer in play for the firm and the other is currently supplied by the vendor (both situations mentioned above).
Also, on the call, Ciena stated, “[T]he key driver for growth is the amount of capacity that the [DCI] applications are consuming [a]nd that amount of capacity is growing very fast, which means the number of units you're going to be selling in terms of Waveservers in that market is going to be substantially higher [than the 6500].” Yet, it does not take into the consideration the movement in the sector to OLS, and that the rate of price declines on a per wavelength basis will be more precipitous in the DCI space than in the traditional carrier market.
Moreover, in the earnings transcript, Ciena provided a rundown on the DCI vendors. ADVA Optical Networking should have probably been included as one of the “key players” – and of course, with the transition to OLS, certain components suppliers may get into the mix as well. In addition, the shift in an OLS direction may also open up the door to Chinese vendors for infrastructure that carries US federal government traffic, especially Huawei, because the resistance could eventually become less severe when it comes to componentry than with a full system.
While we would not be too surprised if Ciena has an increase in its growth rate next year, the absence of a satisfying narrative from the manufacturer is what creates a healthy amount of skepticism. More ominously, when a leader in the optical systems space cannot resist the temptation to move down the food chain for short-term gains, it can easily result in disastrous consequences for the entire equipment market in the long-term future.
[written by Mark Lutkowitz]