Ciena On A Roll With Carrier Spending Picking Up

It looks like the good times have arrived for Ciena (Nasdaq:CIEN), as this optical telecom equipment company delivered another beat-and-raise quarter with its fiscal third quarter results. Although carrier spending is not uniformly strong, Ciena shares could move higher as telcos loosen up their purse strings and move forward with badly needed capacity upgrades.

Another Strong Quarter
Ciena revenue rose 14% from the year-ago quarter and 19% on a sequential basis, beating most analysts' expectations. Revenue for both converged packet-optical and packet networking were strong, up 23% and 104% respectively. Optical transport was weaker (down 26%), but still up 15% on a sequential basis. For the quarter, Ciena had two customers (unnamed, as is typical, but most likely AT&T and Verizon) account for 10% or more of revenue (almost a third of sales in total)-plus customers, totaling almost one-third of sales.

Margins continue to improve on a non-GAAP basis. Gross margin improved four points from the year-ago level to more than eight percent (though down four points sequentially), beating sell-side expectations by a point. Operating income more than tripled (and more than doubled sequentially), coming in almost 50% higher than the average Street estimate.

Another Beat, as 100G Spending Kicks in
While sell-side analysts were a little cagey about Ciena's outlook going into this quarter, they needn't have worried, as the company lifted revenue guidance for the fiscal fourth quarter. At the new midpoint of the revenue guidance range, Ciena management is looking for about 7% growth and a total nearly 5% higher than the prior Street estimate.

Strong 40G/100G deployments (optical transport and edge routers) starting to drive the equipment market, as companies like Verizon (NYSE:VZ), AT&T (NYSE:T), and Comcast (Nasdaq:CMCSA) finally begin to spend in earnest. That's not only good for Ciena, but also good for peers like Infinera (Nasdaq:INFN), Cisco (Nasdaq:CSCO), Juniper (Nasdaq:JNPR), and Alcatel-Lucent (NYSE:ALU) (particularly in edge routers).

But Can It Last?
The tricky part of investing in companies like Ciena is the lumpiness of the carrier spending cycle. Although major carriers like Verizon are always spending money on network equipment, the really big pushes occur about once a decade, as the older technology gives way to the new. This adds volatility to the revenue and earnings of a company like Ciena.

On the plus side, the huge growth in network traffic (roughly 23% a year through 2017 according to a white paper from Cisco (L-a)) argues that the carriers have to spend a great deal more on their networks to keep up. That, in turn, means several years of strong growth for Ciena before the opportunity subsides again.

On the other hand, though, a lot of technologies and approaches are coming to market that are designed to more effectively manage traffic and hardware, allowing carriers to do more with what they have and spend less on equipment. Communications service provider Cyan (Nasdaq:CYNI), for instance, pursues a business model almost entirely built around reducing the need for edge routing and SONET DWDM. Likewise, the software-defined networking (SDN) concepts being advanced by companies like Cisco and Cyan are also aimed at making more effective use of existing hardware, thus reducing capital spending needs.

The Bottom Line
While alternative methods of managing traffic and SDN may take some of the edge off of long-term network hardware demand, I don't think it's going to impact the strong 100G cycle that Ciena is looking at over the next few years. With that, I still believe there's room for this stock to head higher.

I haven't changed my long-term assumptions all that much (long-term revenue growth of 8%, free cash flow growth of 22%), but I've tweaked the timing a bit such that the fair value moves up to $24 per share. That's not a big number relative to today's price around $23, but I do believe the odds favor more beat-and-raise quarters on the way and the possibility of upward revisions to that target.

Disclosure: As of this writing, the author has no financial positions in any companies mentioned.