Optical Networking Growth Can Take This Telecom to New Highs

The increasing deployment of fiber-optic networks across the globe is a tailwind for this stock.

Jul 7, 2014 at 4:00PM

Networking specialist Ciena (NYSE:CIEN) received a significant boost in June after releasing strong second-quarter results. The results beat analysts' estimates, and Ciena guided for a better performance in the second half of the year. The company believes that increasing demand from telecom customers and the adoption of optical-networking infrastructure will drive its business. Having clients such as AT&T (NYSE:T) and Vodafone (NASDAQ:VOD) will also help Ciena to tap into the infrastructure market, enabling it to sustain the strong financial performance seen in the last quarter.

A strong quarter
Ciena's financials are improving at an impressive pace. For the second quarter, Ciena's revenue increased to $560 million from $508 million last year. The bottom line improved at an even better rate. Ciena's adjusted net income for the second quarter came in at $19.4 million, as compared to an adjusted net income of $2.2 million last year.

Its gross margin in the quarter was 43.1%, up from 42.5% last year. The momentum is expected to continue as Ciena's adjusted gross margin will remain in the low-to-mid 40% range in the third quarter.

Getting better
There are three reasons why Ciena will continue getting better. First, it is capturing a larger share of Tier 1 carrier spending by expanding its addressable market, driven by diversified offerings beyond pure optical infrastructure. Second, it is broadening and diversifying its customer base. Finally, Ciena has aligned its solutions according to the new requirements of an emerging on-demand networking model. 

According to management, carriers are shifting their spending toward packet optical solutions. Dell'Oro rates Ciena as the No. 1 player in packet optical solutions worldwide, placing it in a solid position to benefit from this transition. Ciena is expanding its applications within Tier 1 accounts because of this shift, and as a result is now involved with multiple projects at different carriers on a more strategic level. 

Telecom prospects
Ciena's focus on carrier-managed services and applications such as cloud services, data center interconnection, and other applications have helped it gain traction in the market. As a result, the company has strengthened its relationships with Tier 1 service providers.

For instance, AT&T is one of Ciena's biggest customers, contributing 18% to the top line in fiscal 2013. AT&T is now getting ready to introduce a fiber-optic network as a part of its Project Velocity IP initiative. In April, the telecom company announced its intention to expand its ultra-fast fiber network to around 100 cities and municipalities nationwide. This initiative will include 21 new metropolitan areas. AT&T is planning to deliver broadband speeds of up to 1 Gigabit per second. 

On the other hand, Ciena's is also expanding its international reach. Earlier this year, it completed a successful field trial of 400Gb/s data transmission for Vodafone in New Zealand. Vodafone is looking for opportunities to deploy faster fiber networks across the globe. It is now planning to build a fiber broadband network across Ireland to enable connectivity between 500,000 premises in 50 towns at a cost of $612 million.

Vodafone is the world's second-largest mobile operator, and as it scouts for more opportunities across the globe, Ciena will benefit.

Beyond telecom
Apart from telecom, Ciena is focusing on Web 2.0, which is one of the fastest growing non-telco segments for the company. Web 2.0 includes customers such as Internet content providers and data center operators. 

Ciena is now working with most of the major Web 2.0 players, either directly or indirectly. It counts two of the top five Web 2.0 players as customers, according to management. The company is collaborating with traditional network operators to supporting their Web 2.0 customers with both infrastructure and carrier-managed services.

The bottom line
Ciena's strong position in optical solutions has helped it bag clients such as Vodafone and AT&T. As these telcos are busy upgrading to fiber networks, demand for Ciena's solutions should increase going forward. The company's stock trades at a forward P/E ratio of less than 16, indicating that it could be a good buy as its bottom line is expected to grow at a compound annual rate of 16.7% till 2019.

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Sharda Sharma has no position in any stocks mentioned. The Motley Fool recommends Vodafone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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