Ciena: Looking for the Light

 | Mar 13, 2014 | 9:30 AM EDT
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This week industry bigwigs from all over the world have gathered at The Optical Fiber Communication Conference and Expo in San Francisco.

Executives are forecasting a strong equipment upgrade cycle and investors have jumped on the trend. But we've heard it all before. Analysts have been predicting a widespread recovery ever since the dotcom bubble burst. For optical equipment makers like Ciena (CIEN) is there light at the end of the tunnel?

I have followed the optical networking business since the 1990s and every year since the dotcom bubble burst I've heard all kinds of wildly optimistic forecasts. There was an industry-wide recovery between 2010 and 2012. As a major player, Ciena fully participated in the recovery. In fiscal 2009, Ciena's revenue declined almost 28% as the bottom fell out after the global financial crisis.

 But the industry recovered in 2010 and Ciena's revenue grew 89% and the company tacked on another 41% in 2011. The next year, however, business crashed and revenue grew just 5%. Last year, the company climbed out of the hole and posted almost 14% growth and revenue of $2 billion.

Most investors think the big driver of optical networking comes from the growth of the Internet. It really doesn't. While the Internet is growing, it's not growing as fast as wireless. The growth in optical networking comes from what is called backhaul. Wireless companies need huge pipes to carry all the smartphone traffic coming off their cell towers. They use tons of equipment to get the job done.

Widespread optical network upgrades are very expensive and usually correspond to economic cycles. Companies save money by addressing bottlenecks in their networks by using less expensive 10G bits per second and 40 gigabits gear. But they can't plug the holes for much longer.

As the price of 100Gbps equipment drops, companies like AT&T (T) are upgrading the core of their networks. AT&T is in the midst of a huge 100Gbps upgrade called "Project VIP".

Just the other day, AT&T said it would spend $7 billion to expand its wireless and wireline capability in California. When it's all done, AT&T expects to spend some $14 billion on Project VIP. The plan is to add broadband and video services to over 300,000 customers and connect 88,000 business customers at 3,200 multi-tenant business buildings. AT&T is already spending another $5 billion to hook up Georgia.

While AT&T is aggressively building out its fiber offerings, Verizon's FiOS service is at a standstill until it returns its investment. Verizon (VZ) isn't adding new markets until it can shift more of its copper wireline customers to FiOS. Last year, VZ switched over 330,000 cooper customers to FiOS and is on track to add another 300,000 this year. In the wake of the Comcast Time Warner merger, both AT&T and Verizon have speeded up their deployments.

Besides the big telco players in the US, the Chinese have been aggressively building out 100Gbps fiber networks. When you add up the 15 largest service providers, the industry is expected to grow on average 8% a year until it reaches $15 billion worldwide sometime in 2018.

Because of its strong product line, I would expect Ciena to grow faster than the industry for the next few years. Analysts think CIEN will grow revenue 10.5% this year to $2.29 billion.

The Wall Street estimate for Ciena seems low since the mix of equipment is rapidly changing from 40Gbps to 100Gbps. By 2018, just four year away, almost 80% of the optical equipment sold should be 100Gbps. That shift should benefit Ciena. Right now, most 100 Gbps ports are at the core of the network, but that is rapidly changing as service providers push out the latest technology to the edge of their network.

I think there is some light at the end of the tunnel for Ciena.

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