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This High-Flying Tech Stock Is on Sale After a Massive Crash

By Harsh Chauhan – Updated Sep 8, 2020 at 9:39AM

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Near-term weakness in the business environment has investors worried, but they should focus on the bigger picture.

Ciena's (CIEN -2.19%) high-flying run on the stock market ended abruptly after the telecommunications networking equipment and software services supplier's fiscal 2020 third-quarter results came with bad news about its near-term prospects.

Though Ciena trumped Wall Street's revenue and earnings estimates, its fiscal fourth-quarter revenue guidance fell woefully short of expectations thanks to a slowdown in demand. Ciena anticipates just $820 million in revenue this quarter at the midpoint of its guidance range, compared to analysts' expectations of $1 billion. CEO Gary Smith's words on the latest earnings conference call were enough to spook investors, who were quick to press the panic button, sending Ciena shares down nearly 25%:

Specifically, we began to experience a meaningful slowdown in orders and a softening of our outlook. I would stress that the decline is broad based across our service provider's customers globally, whose spend now appears to have been somewhat front-end loaded in the calendar year, resulting in lower orders in our third quarter from a number of our large customers in this segment.

CIEN Chart

CIEN data by YCharts

Ciena shares had run up 40% in 2020 before the results came out, so it wasn't surprising to see investors book their profits at the first sight of trouble. But the optical transport provider's crash should be of interest to savvy investors looking to buy a tech stock at a cheap valuation. Here's why.

Ciena investors should focus on the forest instead of the trees

There is no doubt that Ciena's near-term forecast is a cloudy one. The company delivered $968 million in revenue in the fourth quarter of fiscal 2019, which means that it is looking at a 15% top-line contraction at the midpoint of its forecasted revenue range. Additionally, Smith's statement that there is a broader slowdown in telecom spending after a strong first half in 2020 is another point of concern.

Buy, sell, hold, and dollar sign written on four sides of a paper.

Image source: Getty Images.

Ciena indicates that telecom companies have started being thrifty about their expenses, leading to an increase in equipment deployment times and the rollout of new services. Additionally, the new deals that Ciena had struck are taking longer to ramp up than originally expected. All in all, Ciena says that broader economic uncertainty is leading customers to tread cautiously with respect to spending.

However, Ciena management remains confident about the long-term prospects of the business. Though the company accepts that it is difficult to judge the duration and the effect of the COVID-19 pandemic on its business, secular growth drivers such as an increase in network traffic, higher bandwidth demand, and the growing adoption of the cloud will drive long-term demand.

The more important thing is that Ciena has been racking up customer wins at an impressive pace to take advantage of the long-term growth story. The company claims that it has "secured roughly 50 design wins" for its WaveLogic 5 Extreme optical transport platform as carriers around the world prepare to increase network capacity. In fact, Ciena says that more than 40 customers are using over 1,000 WaveLogic 5 coherent modems around the world in just the first three months of the product's commercial availability.

What's more, Ciena forecasts that customers will eventually need to upgrade their networks to catch up to the increase in bandwidth demand, which is why the weakness shouldn't last for long. Smith added on the conference call:

With bandwidth demand increasing at approximately 25% to 30% year-on-year, we do not believe it will be possible for our customers to serve that level of demand for more than a few quarters without increasing capacity.

A great time to buy

Ciena had warned investors earlier that it may witness a slowdown in business activity because of restrictions related to COVID-19. That warning has come true now, but investors with long-term horizons shouldn't worry much, as the company is sitting on lucrative catalysts such as 5G networks, and controls nearly a fourth of the optical networking hardware market.

The good news is that the latest crash has made Ciena stock attractive from a valuation point of view. Its trailing price-to-earnings (P/E) ratio of 18 is around a third of the five-year average multiple of nearly 55. The forward earnings multiple is also quite reasonable at 14. The company ended the quarter with nearly $1.2 billion in cash, which easily exceeds its long-term debt of $680 million.

As such, investors looking to take advantage of long-term growth trends such as 5G and the transition to the cloud should take a closer look at Ciena, as it could regain its mojo in the long run.

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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