Wednesday, August 15, 2012

Ciena's Prospects

A decent set of results from Ciena (NASDAQ: CIEN) sent the stock racing higher amidst another down day for the market. In fact, what was really surprising about these results was that they were surprising. Well, at least to the market!

Ever since Cisco Systems (NASDAQ: CSCO) reported a weak set of results and guidance, the short sellers have been out in force with regards to many technology stocks. However, all Ciena had to do was generate a decent beat (which is not unusual for a company with such lumpy revenues) and give guidance of which the mid-point implies flat sequential revenue, and the stock was up 14%.

I think we have a rather odd situation in the marketplace right now. Cisco’s conference call murdered sentiment toward the technology sector. At the same time, we see the odd fund manager talking about a stock like Danone being a safe haven. Of course, Danone has heavy exposure to Spain. So, would you rather buy a food company exposed to an economy in recession or a technology company (with minimal southern European sales) exposed to secular growth trends like, mobile, bandwidth usage or cloud computing? Go figure.


Ciena Dancing through the Gloom

A lot of short sellers got burnt in Ciena's post earnings reaction and this could be a sign of things to come. Current expectations are so low for technology that the risk is on the upside.  Taking Ciena as an example, some analysts were talking about lowering their full-year estimates after these results. Gross margins came in lower than expected at 39.6% when the company is aiming to hit a number in the 40s. Moreover, there were some concerns about declining switching revenues. Essentially, the two issues are linked because switching products tend to have higher margin than transport.



No matter. These results were good enough.

Ciena spoke confidently about an overall pickup in the second half and made reference to service providers’ willingness to migrate to 100G networks. This confirms what telecom testing equipment provider Ixia (NASDAQ: XXIA) said earlier this year, so both sets of investors should be feeling better about the outlook now. It’s a particularly good trend for Ciena because it is believed to hold an 85% share of the 100G optical transmission gear market. Cisco actually gave good numbers for switching in the last quarter but perhaps its weak guidance is a consequence of a relatively weaker positioning in the 100G marketplace?

With regards to Ciena’s guidance, the company guided Q3 revenues to be $455-485 million. The mid-point of this is close to the analyst consensus of $470 million. Like I said, these results were nothing spectacular.


Macro-Environment

Investors should be looking for a second half pickup in switching with Ciena. As for the macro-environment, management talked of emerging market opportunities and strength in North America counteracting softness in Europe. Quoting from the conference call…
“While not significantly better or worse than we've seen in recent quarters…  ...increasing opportunities in Latin America, Asia Pacific, the Middle East and especially North America… …helping offset the lingering softness in Europe… …the macro climate may be affecting overall CapEx spend, we continue to see, as we've said in previous quarters, that customers are shifting a greater percentage of their CapEx towards next-gen solutions”
Unfortunately, today’s Euro Zone PMI data did nothing to dispel fears that Europe is heading for a protracted contraction and the ongoing crisis in Greece continues to damage business sentiment. Investors should be mindful of the risk in these events but they should also be aware of the rewards!
A successful resolution to Greece -- which could involve a Euro Zone exit -- is likely to see a release of pent up investment demand in Europe. If so, Ciena could see some upside from its current targets.


Ciena’s Stock Sharply Higher

In conclusion, Ciena gave a decent set of results but nothing spectacular. Sure, they beat estimates but then telecommunications capital expenditures are usually lumpy and this always shows up in Ciena’s results. The next quarter’s guidance was basically in line, but gross margins were disappointing. However, the stock closed sharply higher.

I think this is recognition of the fact that many stocks have been bombed out on fears of a severe global contraction that is not likely to happen. The demand for bandwidth and necessity for service providers and telcos, to upgrade their networks to next generation technology isn’t going away any time soon.