Ciena Due Diligence By Rutvij Thakkar

Tl;dr CIEN is a relatively undervalued telecommunications company that should see tremendous growth in the next few years.

Ciena provides telecom hardware and NaaS or networks as a service to multiple large network providers including AT&T and Verizon. They provide hardware through their converged packet optical solutions such as their Waveservers which give datacenters high-bandwidth connections for single span, metro, long haul, and subsea connections. These devices constantly generate more return on assets for Ciena compared to their primary competitor, Juniper (JNPR) at 7.4% ROA against JNPR’s 4% ROA. Juniper also has decreasing cash reserves and operating cash flows, which shows a decreasing dominance in this industry. Other hardware/optical solutions from Ciena are created with the goal of “scaling capacity, increase transmission speeds, allocate traffic and adapt dynamically”, and most of these goals are met uniquely by the products they provide, their Waveservers have great adaptability with the physical product itself being easy to install and stackable plus a provided suite of software management interfaces and APIs for ease of use. Ciena’s Blue Planet AI gives network providers (like Verizon) data analytics to help them optimize their networks, but they also have bandwidth on demand, which basically helps companies that provide on demand services provide them faster and more efficiently, with the AI automating bandwidth usage to reduce fulfillment costs by up to 90% against static services. This along with network virtualization rounds out Ciena’s network pitch, which also has a nice tie-in with making cloud-based services, streaming, and cellular traffic more network-efficient. More specifically, things like edge-based computing (VR/AR/cloud gaming), ML, Ultra-HD video, and 5G cell networks are going to become much more efficient if companies dealing in these products use Ciena’s services. So as you can see Ciena has a diversified customer base, they’re not just a networking and telecom solutions company, they provide so much more in terms of value creation for web-scale companies. The best thing about Ciena is that even though it’s a modern tech company, it’s still asset intensive, which means that there’s a far lower chance one will just find a substitute for it. Many of the other tech companies I’ve looked into only have services as their niche and lack any real assets to back them up. Verizon, AT&T and CenturyLink are huge customers of Ciena’s and make up greater than 20% of their total revenue. This is a good sign in the sense that Ciena has huge customers that’ll constantly require their services and it’s also not necessarily good because a large portion of their total revenues also rely on the fact that these companies won’t just acquire another company that can develop similar services in-house for a lower cost. Thankfully, Ciena has lots of development going on the web-scale side anyway: “Sales to Web-scale provider customers, representing approximately 22% of total revenue and growing over 40% year-over-year, were an important contributor to our annual revenue growth”, so their consumer base should be further diversified in the near future. Ciena is also planning on expanding into foreign markets, but their first two foreign countries will be Canada and India (arguably the country with most potential for private infiltration into telecom and 5G networks considering the amount of cloud-based companies that operate from there) and they will provide converged packet optical services to Airtel, Jio (Facebook recently partnered with them), and Vodafone, the biggest cellular connectivity providers in India, which has really helped their bottom line: “After recent years of strong growth driven by aggressive network build outs by service providers in India, capital spending in this region decreased year-over-year. We believe our business and financial performance in recent years highlights the benefits of our diverse global business and our ability to target high growth segments within our markets.”

The management team believes that this is what they’ll be targeting in terms of the market opportunity they’re taking on: “The business models of many network operators are under pressure to constrain their capital expenditure budgets, as they cannot grow their network spending at the rate of bandwidth growth. To address these growing service demands and better manage network cost, many network operators are looking to adopt next-generation infrastructures that are more programmable and better capable of leveraging data for network insight, analytics and automation.”

Ciena’s price recently tanked a lot due to them throwing caution to the wind that COVID would certainly cause challenges despite the recently strong growth for them earnings-wise, but the first line of the last 8k was the following: "We delivered outstanding financial results in the third quarter, reflecting our continued innovation, market leadership and strong competitive position in an uncertain macro environment,“ said Gary Smith, President and CEO, Ciena. “Although COVID-related market dynamics have resulted in an order slowdown and are likely to adversely impact our revenue for a few quarters, we are confident in our ability to continue executing on our strategy and expanding our market leadership."

I’m not sure why the market then reacted with a 25% dump in stock prices, because I highly doubt earnings will even suffer by much. I believe that these days just being conservative with your opening remarks is enough to scare investors into selling, especially during a volatile market like this. But fear not because Ciena has a beta of 0.80 and average target price of $57.47, so buy the dip. It’s only because of the tech slowdown compounded with neutral guidance that CIEN slumped, there’s not going to be much more room for going down so buy before a new bullish trend begins.

Now let’s jump into the financials (just remember that Ciena has had several acquisitions throughout the years), where I think Ciena really stands out:

Ciena has had consistently growing gross profits from both products and services for the past three years, and revenue has grown about 30% over the past 3 years.

Decreasing short and long term liabilities and increasing cash reserves are always a great sign, as lower liabilities will strain their balance sheet a lot less and hopefully decrease the cost of debt.

Consistently increasing free cash flow

Increasing return on invested capital (ROIC) (due to lower debt, higher margins)

Increasing operating margins

Lowering days for cash conversion (Days inventory outstanding + days sales outstanding - days payable outstanding, this basically tells you how long it takes for a product to convert back into cold cash)

Decreasing SG&A expenses/per $ of Profit means the company has to spend less

Ciena still has a lot of room to reduce operating expenses however, and that’s a sign of either a company in a heavily competitive environment or a company which has yet to develop. But if there’s one thing I’ve learned from the investment books that I’ve read, it’s that your returns will be better when you invest in a company whose competitive advantage has yet to fully develop, rather than investing in a company with huge net profit margins and low opex (this usually means the company is already established).

Huge jump in operating cash flows from 2018-19

Increasing cash reserves for the past 3 years indicates more financial stability, and this along with a current ratio (assets/debt) of 3

Ciena has great valuation metrics as well considering it's a futuristic tech company that'll be a pioneer in 5G development, with a P/E ratio of 16.7 and a P/FCF ratio of just 13 plus a current ratio of 3 indicates that it is trading at approximately half of the multiples valuation of its nearest competitor, Juniper. Ciena also has a higher net profit margin (10.3% vs 7.9%) than Juniper primarily as a result of lower interest payments and operating costs. This is so remarkable because Ciena has a lower gross profit margin (Revenue-COGS/Revenue) than Juniper.

Because of the recent dump in the stock price, Ciena is at a perfect buy-in point now, and it’s only up 3.5% YTD because of it. Increasing margins and overall returns make this a prime candidate to sustain a recession and advance to higher highs when the full potential of this company is realized. With tremendous web-scale growth and a unique AI enterprise product, this company sets itself apart in the telecom arena and has tons of growth potential outside of and inside of the telecom sector. Ciena has no other competitors of its size (which is relatively small with only a 7B market cap, just showing you how much growth potential there really is). Also Ciena makes exclusively optical hardware products to focus on, where it has other big competitors who actually lag behind Ciena when it comes to market share and innovation. (https://www.sdxcentral.com/articles/news/cisco-ciena-huawei-and-nokia-lead-optical-vendors-ihs-says/2018/07/)

Don't forgot to mention Ciena’s seasoned leadership core, which includes the former CFO of AMD. This team is far more experienced and visionary than most (usually stagnant) telecom giant companies.

Ciena Due Diligence.pdf

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