Ciena staging comeback by diversifying

THE BALTIMORE SUN

As consumers reap the benefits of growing services like on-demand television and free telephone calls over the Internet, one local company may be a less obvious profiteer: Ciena Corp.

The Linthicum-based telecommunications equipment company rode the technology wave in the 1990s, dazzling Wall Street with an initial public offering in February 1997 that gave Ciena the highest first-day value at that time for a venture-backed startup. But when the tech bubble burst in 2000, it wasn't long before Ciena, too, started to feel pain.

Now, nearly five years since the company was last profitable, Ciena's chief executive says this will be the year the business sees a profit on an "as adjusted" basis. Ciena says its effort to expand its business beyond the core equipment it provides for fiber-optic networks has brought in a host of new clients and added new products to sell to existing customers such as AT&T; and Verizon.

Some analysts, though, question how successful Ciena's strategy of growth by acquisition has been. But the company argues that not adding those new businesses would have been an even riskier path to take.

"We're stronger now from both a broader technology perspective and from a customer base," CEO and President Gary B. Smith said during a recent interview in his corner office.

In Ciena's early days, the company was known for long-haul transport gear, which carries data from one side of the country to another, and switches for fiber-optic networks. The switches are essentially the on- and off-ramps on the information superhighway, packaging information to be shipped in e-mail, videos or other formats from coast-to-coast and readying the information to be delivered as it comes off the highway.

But the market for those products dried up during the technology downturn, when carriers realized their networks were overbuilt.

There was already too much fiber cable in the ground. As the economy turned, Ciena suffered several rounds of layoffs and saw its 2001 losses reaching $1.8 billion.

Its comeback strategy, the company said, was to grow its product line through acquisitions. Ciena's customer base now includes 22 of the 30 largest carriers, seven of the top 10 cable companies, and more than 50 enterprise customers, Smith said.

The company has about 1,500 employees, including about 600 in the Baltimore area.

During the past five years, Ciena acquired a half-dozen telecom companies in deals valued at more than $2.1 billion. The largest of those deals was in 2001 when Ciena spent $1.1 billion on privately held Cyras Systems Inc., a California company that makes optical switching systems for metropolitan networks, rather than long-haul (or coast-to-coast) networks.

Then the company made a $397.8 million deal in 2002 to buy ONI Systems Corp., which makes transport equipment to ship data in metropolitan and regional (or tri-state) areas. That acquisition was the first to significantly shift Ciena's focus to include metropolitan networks, the company said. It brought a suite of products for those networks and customers, including Qwest and Progress Telecom, the company said.

The strategy continued in 2003 when Ciena paid $46.2 million to buy Akara Corp., which handles data storage for businesses. Akara's technology moves companies' information to off-site locations to be protected in the event of a disaster. In other words, its technology is the U-Haul truck that moves information from corporate headquarters to a safe, remote spot.

Customers for this product include mostly hospitals and financial companies, Ciena said.

"We placed bets on where we thought the longer-term growth would be," Smith said, noting that Ciena's revenue has grown for the past eight consecutive quarters.

But will those bets pay off? The company has not had a profitable year since 2000, and its last profitable quarter ended July 31, 2001. Smith knows that gambling on new technology and on the telecom market can be dicey.

"That's the risk - you're burning your balance sheet," he said. "You're burning cash, and you've got to have some of those bets pay off."

Financial cushion

But Ciena still has a financial cushion. At the end of its fiscal fourth quarter, Ciena had $952 million in cash and short-term investments - $35.9 million less than it had at the end of the previous quarter.

Its stock is up 43 percent this year, closing at $4.35 yesterday.

The company predicts it will come out of the red (on a pro forma basis) this fiscal year, which runs from Nov. 1 to Oct. 31. Pro forma numbers do not include expenses such as restructuring costs and are often different from numbers derived by generally accepted accounting principles required by government regulators.

Ciena, which is scheduled to report earnings for its fiscal first quarter today, will not say when it expects to be profitable under generally accepted accounting principles.

While some analysts agree with the company's financial predictions for this year, not all tout Ciena's strategy to get there.

Simon M. Leopold, a senior vice president at Morgan Keegan & Co. Inc. who follows Ciena, believes the company's plans to diversify rather than depending on a single sector is a good one. "That said, I don't think they're having the success that one would hope, having entered what would appear to be more promising subsectors," Leopold said.

Tim Daubenspeck, a senior networking equipment analyst for Portland, Ore.-based investment bank Pacific Crest Securities, says Ciena's acquisition strategy has been "more unsuccessful than successful."

Daubenspeck said the 2004 Catena Networks acquisition has not gained any traction from a revenue and product acceptance standpoint, and the 2003 WaveSmith Networks acquisition has contributed little to Ciena's revenue.

Catena's equipment allows customers to add high-speed Internet access to their existing phone lines, and WaveSmith makes switches that collect information and move it onto the network.

But Ciena's 2004 acquisition of Internet Photonics appears to be working, Daubenspeck said. That company combines and moves data, video and other traffic along fiber-optic networks.

Daubenspeck expects Ciena to turn a slight pro forma profit in the October quarter of this year, which he attributes to the company's improved efficiency in manufacturing and an increased demand for bandwidth.

Indeed, Ciena executives say the convergence of voice, data and Internet services will be a plus for the company. With services like digital subscriber lines and on-demand video becoming more prevalent in homes, the need for bandwidth is increasing - along with the demand for Ciena's products, Smith said.

More upgrades

Several carriers are upgrading their fiber-optic networks to be able to offer new applications, such as Voice over Internet Protocol technology that lets consumers make free phone calls over the Internet, and to stay competitive with the cable companies, analysts said. Verizon Communications Inc., for instance, now offers television service in some areas.

What these upgrades add up to, Ciena executives and some analysts agree, could be good news for Ciena, which sells equipment to make those improvements. British Telecom, for instance, is building a new network dubbed the 21st Century Network, and Ciena is one of its suppliers.

"From the point of view of a vendor like Ciena ... that carriers are going to be increasing their capital expenditure is wonderful stuff," said Lisa Pierce, a vice president for Forrester Research who specializes in business-class telecommunications services.

The market for "next generation" telecommunications equipment, which Ciena makes, was $6.9 billion last year, according to Yankee Group estimates. It is expected to grow into an $11 billion market by 2009.

Instead of just having a phone line and, perhaps, a DSL line into homes, telecommunications companies are bringing services such as high-definition television.

Excess demand

But the existing networks won't necessarily be able to manage all the services coming into homes in the future, said Nick Maynard, a senior analyst in the communications network infrastructure division for the Yankee Group.

"Those transformations in services are pushing on the networks and they are currently unable to meet the future demands and capacity increases that are going to be coming down the road over the next two to three years," Maynard said. "Ciena is well-positioned to be able to support that transformation."

stacey.hirsh@baltsun.com

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