Why Cisco Isn't Pointing the Way Ahead for Ciena

Cisco (NASDAQ: CSCO  ) reported a weak set of results recently and gave even poorer guidance, so telco investors must have had a certain amount of trepidation over Ciena's (NYSE: CIEN  ) earnings. In the end, Ciena's recent fourth-quarter revenue topped analysts' expectations, but missed on earnings.  In addition, the guidance was slightly weaker than analysts expected. The market immediately sold the stock off. Does this mean the telco industry is set for another year of AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) trying to ruthlessly cut back on expenditures? And is Ciena's status as the "go-to" play in telco under threat?

Ciena misses, but not by much
The "Cisco effect" was always going to hang over Ciena, but the market looks to have been a little harsh in marking Ciena down nearly 7% after the results. While revenue of $583.4 million was ahead of estimates, non-GAAP earnings per share of $0.16 was below analyst estimates of $0.24. Moreover, the midpoint of its first quarter revenue guidance of $515 million to $545 million was below analyst's consensus of $537.7 million. Time to get nervous?

It's not time to panic with Ciena
First, telco spending is notoriously lumpy, and in any case, the midpoint of first quarter guidance is only 0.7% lower than analyst estimates!

Second, Ciena beat revenue estimates in the fourth quarter, because of "expected deployments on one of the large international network builds that we referred to last quarter," according to its management. While this will obviously help revenue, it possibly hurt margins due to the razor/razor blade model that Ciena's management referred to on the conference call. This kind of model tends to generate lower margins upfront, but larger ones as customers start buying more "razors."

And finally, don't read too much into the Cisco-Ciena analogy. Cisco saw specific weakness in emerging market spending, and has a far greater exposure to older technology spending than Ciena does. In fact, Ciena's great strength is its exposure to next-gen networking technologies like 40G and 100G Ethernet networking and Optical Transport Networks. So while Cisco is exposed to overall telco capital expenditures, Ciena can prosper as long as telcos are spending in the areas where Ciena is strongest. Indeed, this is why Ciena outperformed much of the sector in 2013.

AT&T, Verizon, and international carriers
The Cisco-Ciena analogy also breaks down when looking at the geographic mix of revenue. Starting with domestic revenue, analysts spent a fair amount of time on the conference call questioning Ciena's management over the outlook for North America. Clearly, AT&T and Verizon will loom large in the picture.Ciena's management declared that it felt "very positive around what's happening in North America", and of the major carriers "said simply, we will do more business with them in 2014 than we did with them in 2013."

Again, investors need to appreciate that telco spending is always lumpy. For example, Verizon's $130 billion deal to buy Vodafone out of its wireless business in the US could cause Verizon to temporarily pause some spending in the near term, but it will also enable Verizon to invest more in its wireless networks without having to share profits with Vodafone.

Moreover, Vodafone will get a lump of cash with which it can invest on upgrading its network. Indeed, Ciena has signed a "global supply partnership" with Vodafone, and also expects " that they will become increasingly a larger customer for Ciena." In other words, it could be a short-term negative but long-term positive outcome for Ciena.

In addition, AT&T's spending is also somewhat contingent on how quickly its project VIP (a plan to 4G/LTE to 300 million points of presence, or POPs, by 2015) will progress. At the time of its recent results in October, AT&T looked to be well ahead of plan with 250 million POPs already achieved. It's reasonable to expect spending to be tempered in accordance with where it is in the plan, but AT&T also announced that it was " strengthening our financial structure and our balance sheet to give us the ability to invest and maintain financial flexibility". Companies don't do such things when they are inclined to slow long-term spending.

And finally, while Cisco is seeing weakness in emerging markets, recall that Ciena is more exposed to newer technologies. Indeed, there is a "greenfield" opportunity in many emerging markets to roll out next generation networking rather than spend on maintaining existing networks. In contrast to Cisco, Ciena's management declared itself "encouraged by markets like Brazil, and India, and Russia, and the Middle East."

Where next for Ciena?
In conclusion, Ciena has good prospects going forward, but don't expect its revenue and earnings not to be lumpy from quarter to quarter. Then again, you shouldn't be buying medium-sized technology companies if you can't handle volatility. As long as the global economy remains in growth mode, then Ciena has good prospects next year.

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