Networking equipment company Ciena (CIEN 11.36%) has been in pullback mode for the last six months, with shares down close to 10% due to a variety of factors. Cisco's (CSCO +0.40%) weak guidance in October last year and Ciena's inconsistent results have been weighing on the stock price. In addition, RBC Capital recently downgraded Ciena from "buy" to "sector perform."
Fool analyst Rich Smith pointed out the reasons why Ciena was downgraded by RBC last week:
Ciena's made some impressive gains in revenue and market share over the past year (sales were up 18% last quarter, for example). But while Ciena's losses are shrinking, actual profits are still proving elusive.
The reasoning behind the downgrade looks pretty sound. Smith goes on to state that Ciena's free cash flow is sinking and a recession would probably "kill it," barring a resurgence in telecom spending. But, in my opinion, Ciena is far from finished and is an opportunity in disguise.
Why Ciena can make a comeback
Improved telco spending would surely give Ciena a big boost. The company counts key telecom player AT&T (T +0.38%) as a client accounting for almost 19% of revenue. Ciena is well-positioned to benefit from a shift in the optical networking architecture and is assisting AT&T in the deployment of its metro services. AT&T has chosen Ciena's 6500 packet-optical platform to roll out its services. That doesn't come as a surprise, since the networking company provides "plug-and-play coherent 40G and 100G solutions for metro, long-haul terrestrial, and submarine applications."
AT&T has been fast expanding its high-speed broadband service after deploying the service in Austin last year. In 2014, Ma Bell plans to expand its fiber-to-the-home infrastructure to more areas. The efficiency of Ciena's 6500 platform is further evidenced by the fact that even CenturyLink adopted this solution to roll out its high-speed Internet services last year. Thus, Ciena has strong customers in the U.S. that are adopting its key products.
Another good thing about Ciena is that it isn't concentrated only in the U.S. The company gets around 40% of its revenue from overseas markets, and it has been gaining traction in Latin America and India. Last year, Ciena won business at Cablevision Argentina, a leading cable TV and Internet services provider in Argentina, for enhancing its broadband network. In addition, the company boasts of Tier 1 design wins in Brazil and India.
Ciena expects to see the positive effects of these design wins this year as it starts deploying its products. This is, again, a key point that Ciena investors shouldn't ignore. Last year, when networking giant Cisco cut its long-term growth forecast, it cited weakness in the emerging markets amid the NSA Internet surveillance allegations.
Cisco's fresh orders from the emerging markets were down 12%, with Brazil down 25% and business from Russia declining 30%. Since most of the data is routed through Cisco's equipment, the company had to face a backlash. But, on the other hand, Ciena seems to be chugging along nicely in the emerging markets, and it expects growth in regions such as Latin America and India.
A better outlook
The outlook for global telecom spending remains strong for 2014 after a flat performance last year. According to Gartner, spending on telecom services is expected to grow 1.2% this year, while data-center spending is slated to rise 2.6%. This bodes well for Ciena. The chances of it getting "killed" this year seem remote, as the industry forecast is positive.
Ciena did well last year despite a patchy spending environment. As the outlook for the current year is better, Ciena's performance should also gradually improve. While it's true that Ciena's cash flow has diminished and the company hasn't posted a GAAP profit for a long time, it won't be wise to ignore the progress that it has made.
In the previous quarter, Ciena's gross margin improved 2.6% sequentially, and the net loss narrowed remarkably to $15.9 million from $47.3 million last year. So, it doesn't make sense to sell Ciena just yet, as the company is showing improvement.
The bottom line
The rebound in telco spending and the presence of key customers might lead to better times for Ciena going forward. The stock has delivered gains of more than 40% in the last year and is capable of going higher, which is why a rough patch of results shouldn't scare investors away.
