While Tech Stocks Burned, Ciena Shined

Baldwin Louie — Thu, 11 Jan 2001 14:00:00 -0800

Last year, Kleiner Perkins partner Vinod Khosla made a brazen prediction about the fiber-optics industry: that nine out of 10 of the industry's startups would eventually go out of business. Khosla's words cast a shadow on the otherwise sexy sector, and suddenly fiber optics looked more dot-com than DWDM. (That's dense wavelength division multiplexing, which today is the sector's core technology.)

But if there's a company that has so far transcended Khosla's forecast, it's 6-year-old Ciena. The company achieved a rare triumph in the stock market last year: Its stock rose 46 percent. (Compare that with Nortel, which fell 68 percent and Lucent, down 82 percent.) The company beat the Street in the fourth quarter, as revenues and profits continued to ratchet higher.

The success is head-turning for two reasons: One, Ciena is giving Nortel, the optical sector's 900-pound gorilla, a run for its money. Two, and even more surprising, is the fact that as recently as 1998 Ciena was hardly a threat. The company was to be acquired by Tellabs (TLAB) that year, but a plummeting stock price caused the merger to fall through, taking Ciena's fragile reputation with it.

"Everybody wrote them off for dead in 1998," says Paul Silverstein, an analyst at Robertson Stephens (dossier). "Now they have a market cap of $30 billion. That's not a bad return in two to three years."

Ciena, based in Linthicum, Md., had CEO Patrick Nettles at the helm when it incorporated in 1994. (The 56-year-old Alabama native came up with the company's name while in the shower.) Ciena built its business privately until its February 1997 IPO; the stock has since returned well over 300 percent.

Ciena's products do one main thing: widen the capacity of telecommunications networks. With the rising demand for fattened pipes and more bandwidth, it's a business that's just getting off the ground, observers say. Large telecom companies are the buyers; Qwest, Sprint (FON) and WorldCom (dossier) rank among Ciena's biggest customers.

The fiber-optics market can be broken down into a few key areas: long-haul transport (think interstate networks) and metropolitan transport (for urban areas, at the edge of networks). Other markets include metropolitan access and optical switching. Ciena is determined to compete in each one, buying its way when need be: It bought ATI Telecom International, a systems installer, in 1998, and followed up with the purchase of Omnia Communications and Lightera Networks in 1999. The latter two acquisitions enabled Ciena to enter the long-haul market, which makes up the bulk of its revenue. A plan to buy Cyras for $2.6 billion is Ciena's most recent weapon, enabling it to quickly take share in the metro-access market.

The purchases seem to be paying off. While Ciena clearly takes a distant second in market share, it has transcended its upstart origins to keep up with Nortel. Competitors now entering the market may find few scraps to fight over: Nortel has a 53 percent share in the long-haul transport market, followed by Lucent at 17 percent, and Ciena with 13 percent and gaining, according to optics research and consulting firm Dell'Oro Group. Nortel has 53 percent of the metro market, as well, with Ciena in second place at 24 percent.

"Does this mean Nortel's business is hurting?" asks Silverstein, referring to Ciena's growth. "No, it continues to be strong. But it's a rising tide, no matter what you're talking about."

Indeed, while the optics playing field has gotten crowded in the last three years, there's a large opportunity for growth. Projections remain strong: The long-haul market will more than double in coming years, with revenue reaching $57.2 billion in 2005, up from $23.5 billion last year, according to the Dell'Oro Group. Revenue in the metro market was $383 million last year and is expected to be $3 billion by 2005.

Nettles says Ciena is poised to take advantage of it all. To be sure, it has competition: Startups can win some business, and the smartly run Sycamore Systems stands to be a threat. But Ciena execs say they have distinct advantages that will help them win in the long-term. One is the company's size: Ciena is big enough to assure its customers and quash new competition, but is still small enough to be an underdog to Nortel.

More important is Ciena's product suite. While most of today's network activity is manual - creating a headache for customers when something needs fixing or changing - Ciena's products automate networks and allow them to talk to each other. It's a cutting-edge ability that all telecom companies will eventually want, Ciena says. But much of Nortel's and Lucent's current business comes from older network solutions, a fact that may be responsible for the two companies' recently slowing business. As spending shifts toward next-generation products, Nettles says, Ciena will benefit.

"There is a need for networking intelligence," he says. "To deploy bandwidth in minutes, not months; to manage with computers, not people. There are hundreds of people in large carriers who have to grow through enormous, large processes. We are building equipment that allows them to do that." Helping clients build and scale these massive networks, he says, is something Ciena has done in a responsive and cost-efficient manner.

Nettles says the biggest challenge for Ciena in the coming year is to reassure a nervous market, a task he hopes to accomplish by simply delivering on the product and service front. So far, the financial signs are good: Ciena expects revenue growth in 2001 of 75 percent to 85 percent. Concern rightfully exists over the company's stock price, which trades at a lofty price-earnings ratio of 105. (A price-earnings ratio is the most common measure of how expensive a stock is. It's equal to a stock's capitalization divided by its after-tax earnings over a 12-month period.) But execs simply point to the large opportunity before them, saying they hope an increase in business will justify the company's valuation.

Indeed, while some claim that the optics sector is due for a shakeout, there seems to be more evidence of potential growth than there is of a complete collapse. "The extreme is calling it the dot-com sector," says R. Scott Raynovich, executive editor of LightReading.com, a Web site for news on the optical-networking industry. "But this is still a technology market, not a media and retail market. This is real innovative technology."

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While Tech Stocks Burned, Ciena Shined