I realize that many readers have little or no sympathy for sell-side analysts, but I don't envy them the task of figuring out the telco capex space these days. JDS Uniphase (Nasdaq:JDSU) and Oplink (Nasdaq:OPLK) recently offered solid beat-and-raise quarters that stoked hopes that the much-awaited carrier spending rally has finally come. And then along comes Ciena (Nasdaq:CIEN); a company that has been introducing solid technology and gaining share, but sees less strength in the market right now. As befits its space, Ciena is a tough stock to figure out. While much more promising (and not nearly so beaten down) than Alcatel Lucent (NYSE:ALU), Ciena has to start delivering pretty substantial profit improvements for the stock to really work. The potential is certainly there, but then so are above-average risks as well.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Fiscal Third Quarter Results were Solid ... ish
Ciena actually did alright with respect to expected fiscal third quarter earnings. Revenue rose 9% from the year-ago level, while sliding about 1% from the prior quarter. Switching was the leader in sequential growth (up 22%), while transport saw sales down 6% sequentially. Curiously, the performance was flipped on a year-on-year basis (switching was down 7%, while transport was up about 2%).

Like revenue, margins were OK relative to expectations, but not especially impressive on their own. Gross margin (whether GAAP or non-GAAP) fell more than four points from last year and was basically flat sequentially, with service margins not really helping much and the company likely seeing some help from switching. On a GAAP basis the company is still in the red on the operating line, while non-GAAP operating income slid about one-quarter on a sequential basis, but basically met margin expectations.

SEE: A Look At Corporate Profit Margins

And Then There's the Guidance
Unlike JDS Uniphase, Oplink and even Nokia-Siemens Networks, management wasn't too chipper about the near-term outlook. Ciena management cited well-known macro issues, but also delays in deploying projects that the company had previously won. It's hard for me to know what to make of this. I think the company has a great opportunity in 40G/100G upgrades at customers like AT&T (NYSE:T), Verizon (NYSE:VZ) and Comcast (Nasdaq:CMCSA) and I think the company is taking share from the likes of Alcatel Lucent.

At the same time, though, particular projects/installations/rollouts can certainly get delayed and it seems that customer/product/project mix matters more than ever before. In other words, don't be surprised to see Company A have a bad quarter while Company B has a good one ... only to see it reverse in the next quarter or two.

SEE: 4 Industry-Changing Tech Trends

The Bottom Line
I'm attracted to what I see as superior technology at Ciena and the opportunity to prosper with new product and technology launches. What's more, I think carriers have been under-spending relative to their ongoing long-term capex needs, and that that cycle has to reverse at some point. In many respects, then, I can see how Ciena continues to work as a turnaround/rebound play. But there's definitely a down side as well. Alcatel Lucent, Nokia-Siemens and Huawei aren't going to surrender the field and the threat of price-driven competition shouldn't be ignored. The company also has a pretty hefty slug of debt - $1.4 billion in convertible debt (roughly $900 million net) that could translate into 55 million potential shares.

Estimates are all over the place on this stock. While I believe Ciena can grow its revenue by almost 50% by 2017 (to over $2.6 billion) and improve its free cash flow conversion into the mid-single digits, that's only good for a fair value around $14 if you exclude the debt (and $4 if you include it). On the other hand, some analysts believe that Ciena can approach $3 billion in revenue in 2017 with a free cash flow margin in the low teens. Bake the cake with that recipe and you can get a fair value (including the debt) of $22 per share.

SEE: A Primer On Investing In The Tech Industry

Clearly, then, the investment case on Ciena depends hugely on the company's ability to boost operating margins and continue winning share with carriers. If you're bullish on the company's margin leverage (or want a leveraged play on carrier equipment demand growth), this stock can definitely work from here.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing

    The Rise of Corporate Venture Capital

    After the success of Google Ventures, corporate venture capital is an increasingly popular diversification and hedging tool for many large corporations.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Investing

    What’s Plaguing Twitter and Yelp?

    Yelp and Twitter have recently become grounded in reality and unable to justify their sky-high stock valuations.
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!