The Street Seems All In On Ciena's Recovery

By Stephen D. Simpson, CFA | December 14, 2012 AAA

Optical networking company Ciena (Nasdaq:CIEN) reported sales below expectations and lowered its guidance for the fiscal first quarter ... so of course the stock is up about 2% (as of this writing) after the announcement. That's just part of the weirdness that surrounds providers of carrier equipment these days - while 2012 was a pretty rough year, analysts and investors expect big carriers like AT&T (NYSE:T) and Verizon (NYSE:VZ) to start spending again soon. Although Ciena is difficult to value today because of the uncertainty of the pace of the spending recovery, I still believe this is an interesting stock for aggressive investors thinking a few moves ahead.

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Tough Conditions Still Weighing on Results
I've pretty much given up hope that looking at the reports from other equipment companies like Juniper (NYSE:JNPR), Alcatel-Lucent (NYSE:ALU) or Infinera (Nasdaq:INFN) has a lot of predictive value for any other company in the space right now. To that end, while there have been some relatively positive reports of late, it's still a difficult environment.

Ciena saw revenue improve 2% from last year for this fiscal fourth quarter, while sales were down about 2% on a sequential basis. CESD looked like an outperformer relative to expectations (with revenue up 66% year over year), but core optical transport revenue was down 2%. Revenue from software and services rose 21% from last year.

Margins were a real mixed bag, as the company did pretty well on gross margins but saw higher than expected operating expenses. Gross margin fell about a half-point from last year, but rose more than three points sequentially on sizable improvements in both product and service margins. It's worth noting that the changes in gross margin were basically similar on both a GAAP and non-GAAP basis. At the operating line, R&D and marketing costs both rose in the mid-single digits, while "general and administrative" costs increased about 9%. That led operating income (non-GAAP) down by more than half, with a 1.4% operating margin.

SEE: A Look At Corporate Profit Margins

Another Weak Guide, but Is The Recovery Just Around the Corner?
Once again Ciena took down numbers for the next quarter (it's worth noting that this quarter's miss came on lowered expectations). Against the prior Street average estimate of $460 million, management guided to a midpoint revenue number of around $450 million. That's not a big downward revision in my book, but death by a thousand paper cuts is still death.

Ostensibly, 2013 should be a year where companies like Juniper and Ciena return to a bit of their former glory. Ciena has had some well-received product launches, and Verizon and AT&T should be about to get going with their 100G/OTN deployments. Then again, there is very much an element of "we've heard this all before..." to this story.

Underpinning the story is what I see as a basic reality - carriers can't delay their spending forever. At least not if they want to stay competitive and keep those lucrative smartphone customers happy. So, sooner or later, those equipment orders are going to come, and Ciena's share gains and product launches should put them in place to get a good piece of that business.

SEE: Can Earnings Guidance Accurately Predict The Future?

The Bottom Line
I do have some concern that the Street has already baked in these improvements and locked in to the idea that a recovery is coming (and that Ciena will benefit). These shares are up more than 40% over the past year and have almost tripled from their 2009 lows. With concerns about when (and maybe if) those double-digit margin targets will materialize, that might mean that a lot of optimism is already factored into the price.

The uncertain timing and magnitude of the spending recovery makes these shares unusually difficult to model. Nevertheless, I'm tempted to say that fair value is "somewhere higher than today's price" and that aggressive investors can buy still buy these shares with an eye toward benefiting from a healthier spending environment in 2013.

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

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