Riding the wave of exploding bandwidth needs, Ciena (NYSE:CIEN) continues to outperform its industry peers. The company -- a provider of optical and packet networking systems -- recently reported earnings from its first fiscal quarter of 2018, which showed continued market share gains and profitable growth amid challenging industry conditions.
Revenue grew 4% year over year, though adjusted gross margin and adjusted operating margins contracted by 230 and 220 basis points, respectively. While Ciena's stock surged after the earnings report, it still trades at a very reasonable forward P/E multiple of 14.8.
Here are the secrets behind Ciena's current success, and what to watch going forward.
1. It's winning internationally
One of the main reasons behind the lower gross margin was the high number of new customer wins in international markets. According to management, these types of contracts carry lower gross margins than existing contracts in the U.S. The main drivers of international growth were continued strength in India, along with new customer wins in Japan, a country previously inaccessible to U.S. vendors.
In India, the company continued building on its leading position. India is one of the highest-growth countries in the world, and Ciena counts all three major telecommunications providers, several regional service providers, and the Indian government as customers.
Ciena's Japan business is relatively new, as the country had previously opted to use local vendors exclusively; however, now that the global industry is consolidating, Japan has chosen Ciena as an international partner to help it build out next-gen networks. Management claimed that the change has occurred over the last 18 months, which have been tumultuous for many industry players, and Ciena now counts all the major service providers in Japan as customers.
Overall, the Asia-Pacific segment grew 25%, greatly outpacing the rest of the company's 4% growth, and made up 17% of the quarter's revenue, showing the benefits of geographic diversification amid a slowdown in U.S. telco spending.
2. It has integrated offerings
How is Ciena doing so well relative to competitors? The answer is diversification, both geographically and technologically. While the company's bread and butter is in optical systems, Ciena also makes equipment for packet networking, and ties the whole package with an integrated suite of software products. When asked about Ciena's advantages over other more specialized vendors, CEO Gary Smith said:
I would point you to the way that the basic systems operate, right? ... we've done the convergence of the packet and optical features, so we have basically one box that does the work of two. I think for other vendors, they may have to put two or three boxes to get the same kind of functionality. And then, we're adding to that all the software intelligence, the analytics, the orchestration, the automation, the software definition, if you will, that allows the operators -- you know, make the network operate the way they want.
CFO Jim Moylan added, "we're the only viable 400G player out there right now" (400G is the next major industry speed upgrade over the prior 200G generation equipment being deployed today).
Those are big words, as Ciena is not the only player making 400G equipment overall. Specifically, smaller rival Acacia Communications (NASDAQ:ACIA) is thought to have a leading 400G chip, but Acacia is more of an integrated circuit supplier to systems manufacturers, not a comprehensive system manufacturer like Ciena.
3. It's riding the cloud
Finally, while U.S.-based telecommunications firms have been cutting back on spending due to various ongoing mergers, cloud computing vendors also are buyers of Ciena's equipment. In fact, the company's data center interconnect (DCI) division, which serves these cloud customers, has been growing rapidly, and now makes up 15% of the total company revenue.
The success in DCI has come along with the early 2017 introduction of Waveserver Ai, which allows data center operators to easily scale up or scale down their system's capacity, optimizing the cloud data center for both bandwidth as well as electricity needs. The Waveserver is designed to plug right into a data center rack, making it easy for cloud operators to deploy.
Cloud companies are also in the process of laying their own undersea cables, and Ciena has also seized that opportunity, winning jobs for two cables just in January, one crossing the Pacific, and another crossing the Atlantic.
Best house on a bad block
While many optical transport stocks have struggled, Ciena continues to outdo the competition due to its geographic and product diversity. Should other players fall by the wayside, even brighter days may be ahead.
Billy Duberstein has no position in any of the stocks mentioned. His clients may have positions in some of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.