Ciena: The Street Taking a Fresh Look?

In addition to 1) the ex-Nortel crowd desiring to remain firmly ensconced in its controlling role over Ciena’s future, to 2) what we perceived as a previously unusual amount of internal pressure to get the numbers up before reporting every three months, and to 3) buying time as well as keeping expectations in perspective before the anticipated boom in supporting Verizon’s 5G network, the rather atypical approach of developing a multi-year, financial plan appears to be attracting some renewed interest by investors (although not generally a bullish one right now). It is probably perceived as a fairly bold move when specific guidance in the optical space quite understandably never goes beyond the following quarter. At the same time, the “Nortelization” effect has resulted in the same kind of mistake at Infinera with Transmode, with Ciena not taking sufficient advantage of Cyan’s transport products, albeit hardly with the same level of negative consequences.

While there can be a fine line between confidence and cockiness, a distinction that the original Nortel tended to fail at recognizing, we still maintain that a minimum of five percent total growth is not excessive, especially barring any unexpected macro events, and readily achievable given its market position and the operational advantages of its installed base, particularly with its optical cross-connect products. That being said, we do not believe Ciena would take that much of a hit if it happens to dip down to, say, four percent in one year in this highly cyclical business.

There seems to be a good number of analysts on the Street who have doubts about Ciena’s ability to achieve its projected performance. If it truly falls short, it will mean that the optical equipment sector will be in a lot of trouble for a while.

Whatever happens, given the lean expectations for international optics growth in 2018, it is long past time to bag the mandatory slide at many dog-and-pony shows demonstrating the continuing spike up in bandwidth because there is often not a direct correlation with gear purchases. In particular, the incumbent types of Internet service providers can always find imaginative ways to mine for additional capacity with their existing network assets.

fibeReality certainly does not necessarily believe that an announcement by AT&T (with a focus on becoming an entertainment company) in making further buildouts as a result of the corporate tax cut in the US is a reason for overexcitement, as it could have been earlier a part of the overall plan of the operator anyway. Also, the impact of the net neutrality reversal on CAPEX investment has to be tempered by fears that a new administration in the future can result in putting the Title II restrictions back in place.

On the positive side, it does not seem to us that Ciena is really exaggerating “concern around the sustainability of innovation” around the world. It is another advantage of offering the three-year outlook in that the supplier wants to show a high confidence level in its ongoing stability. Another way to put it is that the perceived risk of losing one’s position in choosing Ciena is even further reduced.

Obviously, Infinera’s woes could easily result in increased market share for Ciena. For example, it is hardly out of the question that CenturyLink-Level 3 could at some point just cap the installed base of the former, and only go with the latter for growth.

However, in the same way that Infinera chose to maintain the story of the supposed advantages of its PICs over the more profitable Transmode offerings, the ex-Nortel folks protected their turf in making sure that the ex-Cyan transport solutions would be destined for obsolescence as quickly as possible. Towards the end of 2015, we wrote, “…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.” Similar to Transmode, the Cyan Z-Series systems on the public network side were targeted at tier 2 and 3 customers in which the competition from larger vendors was less intense.

Ciena could have easily explained to the investment community that there would have been no cross-competition with the 6500 in that it was designed for a different space. We heard that Cyan was getting as high as 70% margins on its transport products for customers that would have probably not tended to be interested in the 6500 – a long-in-the-tooth, large tank. Therefore, we suspect that the main reason Ciena is still actively selling a minimum number of these “Cyan” metro devices is to keep its gross margins from dropping too far down.

As always fibeReality does not recommend any securities, and this writer does not invest in any companies being analyzed by us.

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[written by Mark Lutkowitz]