INVESTMENT THESIS
BUY-rated Ciena Corp. (NGS: CIEN) fell 3% in a mixed-to-down market on 12/10/20Cafter the company’s fiscal 4Q20 non-GAAP EPS lagged Street expectations. Revenue was in line with consensus but fell 14% annually, reflecting cautious spending both by the company’s traditional customer base of carriers and nontelco customers. Management forecast a slow tart to fiscal 2021 followed by accelerating strength in the second half, netting out to a flattish year for revenue.
Ciena is experiencing a bifurcated business environment, according to CEO Gary Smith. Ciena has won multiple new business awards, and customers are anxious to upgrade public networks, data centers and enterprise networks to accommodate rapidly growing traffic. While new business engagements are brisk, actual deployments of core and metro network gear have slowed as carriers focus on edge and access (consumer homes) in this unprecedented period.
At the same time, core and metro networks are ‘running hot’ and facing capacity constraints. The company’s confidence in a fiscal 2H21 rebound is predicated on medical advances against COVID-19. Management’s positive outlook also reflects actual orders, extensive business planning, and ongoing engagements with customers. In a challenging time, Ciena has focused on building balance sheet strength and generating strong free cash flows, which are benefiting from rising margins as the company introduces more software into the mix. Ciena continues to invest for the future, meaning that near-term gross margin gains may not fully translate into operating margin expansion. We expect Ciena to grow faster than the market based on the competitive power of its product suite. We also look for Ciena to benefit from geopolitical events that it is uniquely positioned to exploit, meaning the displacement of Huawei in Asian and EMEA carrier networks.
Even flat growth suggests that the company is gaining market share in a temporarily stalled market. Amid investments for future growth, we look for a slight decline in non-GAAP EPS in FY21 as the company shifts to deployments (which are inherently lower-margined). In an environment that has become more challenging, Ciena’s operating cost discipline and richer software mix should drive a return to non-GAAP EPS growth late in FY21 and into FY22.
The volatile CIEN shares trade at sharp discounts to peers and historical comparables.
RECENT DEVELOPMENTS
CIEN declined 14% in 2017, lagging the 7% peer-group gain. CIEN stock rose 18% in 2016.
For fiscal 4Q20, Ciena posted revenue of $828.5 million, which was down 14% annually and 15% sequentially. Ciena provides revenue and P&L line-item guidance but not explicit EPS guidance.
CEO Gary Smith noted that the challenges the company identified three months ago are still in place; the difference is that Ciena now has a more positive view of market dynamics six months out. For the present, Ciena continues to experience ‘increased risk aversion’ among the service providers that comprise the company’s traditional customer base. The slowdown in demand has also been pronounced among non-telco customers, particularly the enterprise and government customers that represent about one-sixth of total revenue.
The CEO repeatedly cited the ‘bifurcated’ nature of Ciena’s business wins compared with its deployment experience. The adoption of cloud architectures is accelerating, enabling networks and data centers to facilitate greater data traffic volumes. They have also pushed more and more traffic to the edge and to access points, meaning our homes.
Ciena continues to see ‘robust’ order activity for core and metro network implementations. But at present, service providers are busy reinforcing network capacity at the edge and access points rather than executing on planned expansions in metro and core. Carriers are letting core and metro networks run hot, and have taken a ‘don’t mess with it’ approach to existing infrastructure.
Carrier plans to address overdue capacity expansion and new network rollouts when the pandemic eases remain in place, and in fact are increasing. For fiscal 2020, Ciena’s book-to-bill ran slightly above 1.0, meaning that orders are stronger than revenue – even with iscal 2020 meaningfully front-end-loaded in prepandemic quarters. The company has onfidence in a second half recovery in actual network deployment activity based not only on nticipated medical advances in the fight against COVID-19, but also on customer engagements, discussions with CTOs, and new business awards along with unfulfilled prior wins that were deferred at the start of the pandemic. A mid challenge that could persist for several quarters, Ciena remains focused on executing its strategy. And, although COVID-19 is temporarily cutting into Ciena’s enterprisedemand, the pandemic has led to acceleration in digital transformation. As a leading provider of optical networking gear, Ciena is helping service providers and data center operators fortify ore and edge networks amid surging data traffic related to work & learn from home. Customers are also preparing for the coming 5G wave and moving to virtual network elements, which plays to the strengths of Ciena’s Blue Planet orchestration business. Ciena has little Chinese exposure; did not suffer the supply-chain disruption in that nation reported by other tech companies; and stands to benefit from the displacement of legacy Huawei network gear in a growing number of nations. CEO Smith pledged that Ciena would continue to invest tosustain its competitive edge. He cited momentum for new products including WaveLogic 5 Extreme, Ciena’s 800 gig optical transport solution. WaveLogic 5 Extreme is approaching 5,000 units shipped for metro and long-haul carrier infrastructure, submarine, and DCI (data center interconnect) applications. WaveLogic 5 Nano, a family of extended-reach pluggable optical transceivers, represents a future revenue opportunity that is beginning to ramp up. Segment and regional breakouts during the recent quarter signal the ongoing secular demand strength for Ciena’s offerings, but also reflect near-term challenges. Americas revenue (64% of total) declined 26% annually and 25% sequentially; demand from Americas-based tier-1 carriers was soft, while weakness was more pronounced among cable MSOs and domestic enterprise and government customers.
EMEA revenue (19% of total) rose 3% annually while edging lower sequentially. Asia-Pacific sales of $139 million (17% of total) rebounded with 40% annual growth, after falling 26% in 3Q20; A/P sales were also up 38% sequentially.
Ciena has little to no presence in China, but sees India as a major market opportunity. Specifically, Indian carriers appear to be moving more rapidly to remove Huawei network products from legacy networks, making room for Ciena gear. Given extensive back-office and software integration, this displacement process can be arduous and will likely take years to unfold, particularly in EMEA. Based on actual business wins, we believe that Ciena will over time displace Huawei at major European carriers including Deutsche Telecom, Vodafone, and BT.
On an end-customer basis, telco sales of $543 million (66% of total) declined 7% year-over-year and 2% sequentially. Non-telco revenue of $286 million represented 34% of total sales; that was down from 43% in 3Q20, which represented the highest percentage contribution to revenue since Ciena began breaking out this category in 1Q18. Non-telco sales plunged 25% year-over-year and 32% sequentially.
Within non-telco, Direct webscale revenue of $179 million declined 7% annually and a much shaper 27% sequentially. We expect the webscale vertical to remain lumpy, but also expect it to remain a leading end-customer vertical going forward, once the global economy moves beyond the pandemic.
Weakness was more pronounced in other parts of the non-telco category. Cable MSO (5% of revenue) fell 48% year-over-year; and Government & Enterprise (8% of total) fell 41%. These two categories can be volatile.
On a business segment basis for 4Q20, Network Platforms revenue of $635 million dropped 0% year-over-year and 21% sequentially. Within Network Platforms, Converged Packet Optical (CPO, 70% of total company revenue) was down 13% year-over-year. The highly volatile and order-dependent Packet Networking niche fell 58% annually. While Packet Networking is subject to cannibalization from CPO over the long term, Ciena retains a strong installed base in this legacy business.
Platform Software & Service revenue (7% of total) rose 32% year-over-year. Blue Planet (network orchestration) grew 26% in the quarter. Global Service revenue of $118 million (14% of total) was up 5% annually. As the company continues to build its installed base of optical transport and switching solutions, Ciena is setting the stage for strong ongoing services revenue.
Ciena guided for a soft first half of fiscal 2021, followed by a catch-up second half and resulting in flat to low single-digit top-line growth for the full year. Based on other elements of line-item guidance and our own modeling, we look for a single-digit percentage decline in FY21 non-GAAP EPS. We are modeling a revenue and profit recovery beginning late in FY21 and extending into FY22.
EARNINGS & GROWTH ANALYSIS
For fiscal 4Q20, Ciena posted revenue of $828.5 million, which was down 14% annually and 15% sequentially.
Non -GAAP earnings of $0.60 per diluted share rose 4% year-over-year while lagging the consensus estimate of $0.63. Ciena provides revenue and P&L line-item guidance but not explicit EPS guidance.
Ciena expects full-year revenue to be flat to up 3%; that implies a range of $3.53-$3.64 billion. Other elements of FY21 guidance include a non-GAAP gross margin of 45%-47%; quarterly non-GAAP operating expenses of $270-$275 million, with variation across the quarters; and a non-GAAP operating margin of 15%-16%.Our revised estimate implies a 7% decline from FY20 non-GAAP EPS. We are implementing an FY22 EPS forecast of $3.24, which assumes an upper-teens-percentage recovery.
FINANCIAL STRENGTH & DIVIDEND
Ciena is consistently growing revenue in a challenging market while strengthening cash flow and reducing indebtedness. As a result, free cash flow is increasing and net cash is growing.
Year-end FY17 net cash was the first net-cash reading since FY09 (when Ciena had net cash of $259 million). Net debt, which was $119 million at FY16 and $253 million at FY15, averaged around $700 million in the FY10-FY14 period.
In June 2020, Ciena temporarily halted its share buyback program. With the beginning of FY21, Ciena intends to resume repurchases. In the first half of FY20, Ciena spent $75 million to repurchase shares. It spent approximately $150 million to repurchase stock in FY19 and $111 million in FY18.
Ciena does not pay a dividend, and we do not expect it to implement one in the near future.
MANAGEMENT & RISKS
The management team at Ciena is headed by CEO Gary Smith, CFO Jim Moylan, and CTO Steve Alexander. Scott McFeely is SVP Global Products & Services, and Jason Phipps is SVP Global Sales & Marketing.
Ciena’s push into adjacencies including webscale, cable MSO, and data center & large enterprise entail risks. If Ciena is unable to generate sufficient scale in these niches, costs could overwhelm profit potential, dragging down total company margins. Ciena, in our view, has demonstrated impressive execution in adjacent markets, and these now represent opportunities to grow revenue, leverage scale, and accelerate margin expansion.
Other risks include a narrow customer focus, reliance on tier-one North American carriers, and an extended period of constrained capital spending at carriers. A further risk stems from the company’s four-pronged development effort, which will cause prolonged non-GAAP losses unless revenues rise meaningfully. These risks are offset by Ciena’s strong technology position, high-quality customer relationships, global market diversity, and expanding customer base both regionally and beyond the carrier space
COMPANY DESCRIPTION
Ciena participates in optical transport and switching, converged optical Ethernet solutions, carrier Ethernet, and global services for its customers. The addition of Nortel MEN in March 2010 more than doubled the revenue base.
VALUATION
CIEN shares appear attractive based on revenue growth and longer-term margin expansion potential.
On December 10, BUY-rated CIEN closed at $46.10, down $1.08.
Source: Argus
