From THE INDUSTRY STANDARD MAGAZINE
Ciena Sees the Light
By Michael Mechanic
Issue Date: Jul 30 2001
Led by Patrick Nettles, the optical equipment maker has stayed a step ahead of the tech recession. But can it avoid the darkness that may lie ahead?
It's the kind of nosedive some companies never recover from. In August 1998, optical equipment maker Ciena was preparing to celebrate its $7.1 billion acquisition by networking firm Tellabs. A generous spread of food and drink was laid out at its suburban Baltimore headquarters, where employees awaited final word on a deal that would put a 14 percent premium on Ciena's shares and catapult the 4-year-old company into the big leagues with the likes of Nortel and Lucent.
Until that day, the company seemed impervious to bad fortune. Founded in 1994, Ciena had developed a pioneering method for moving huge amounts of data over existing fiber-optic cables. The technology soon became the standard. Three years later, it netted a $3.7 billion valuation in the biggest startup IPO Wall Street had ever seen. But Ciena's merger party turned into a wake. An hour before the shareholder vote, AT&T phoned to say it would cease testing the firm's equipment. Wall Street viewed the news as a deal-breaker, and Ciena's stock plunged 45 percent the same afternoon. "People were literally wandering the halls stunned," says John Hatcher, a software engineer in Ciena's Atlanta facility. "We were all deeply affected."
So was business. As the stock tumbled, competitors including Lucent began touting similar technology for less money, even though their gear was still in development. Customers in turn demanded lower prices from Ciena, crushing its margins. "Everybody on Wall Street wrote them off," says analyst Paul Silverstein, who covers Ciena for Robertson Stephens. "The view was that they were too small to compete with the big boys." By October the company's shares were trading below $9, down from a high of $88 three months earlier.
What a difference a downturn can make. In a stunning reversal of fortune, Ciena now thrives while Lucent and other big players struggle - some for their very survival. Ciena's industry is suffering from an expansion binge by telecom carriers. Companies like WorldCom, Williams and Level 3 made huge investments in building high-bandwidth networks only to find that demand for their services wasn't keeping pace. As a result, lenders have fled the telecom sector; many small, cash-strapped carriers have gone out of business while others, big and small, have curtailed their equipment purchases.
Among those clobbered in recent months: Nortel, Lucent and Sycamore, which reported sales down 2 percent to 18 percent for the first quarter over the same period last year. Nortel last week announced a $19.4 billion loss for its second quarter, and Lucent's bonds have been downgraded to junk status. Ciena, by contrast, saw quarterly revenues rise 129 percent and appears on track to double last year's revenues to $1.7 billion this year. While rivals slash staff, Ciena has never had layoffs and continues to expand its product lines. In May, it signed its 50th customer - a milestone in an industry where few young companies have more than a handful of reputable clients.
Ciena has succeeded by inventing a high-bandwidth product that saved clients money, tweaking it to stay ahead of the competition, and having the foresight to broach new, fast-growing sectors. But just as important are Ciena's collaborative culture and a no-nonsense approach to business that shuns hype in favor of results. "Steak before sizzle," a pet expression of Executive Chairman Patrick Nettles, is the company mantra.
Though analysts laud Ciena's performance, pessimism about the entire sector has driven the company's share price to as low as $29 this month, down from $67 in April. Company growth, while still impressive, is slowing down. Revenues for the first half of the year were up 130 percent over the same period last year; estimates compiled by First Call have Ciena growing 98 percent in the third quarter of this year and 76 percent in the fourth. Analysts expect next year's revenues to increase a smaller but still impressive 53 percent. "We're taking the position that Ciena can't stay on this island forever," says Epoch Partners telecom analyst Ashwin Navin. "We held that view a while ago, and now I think everyone's got it."
Nettles, a physicist-turned-executive, was between jobs in January 1994 when he got a call from a business acquaintance, venture capitalist Jon Bayless. A scientist named David Huber, the VC explained, was looking to commercialize some intriguing patents. If Nettles and Huber could forge a deal, Bayless would fund the company.
Nettles saw gold in Huber's invention. Prior to 1996, long-distance carriers relied solely on hardware that translated voice and data into laser pulses and sent them single file down thin glass fibers. To add bandwidth, you had to either speed up the pulse rate (an approach limited by the laws of physics) or lay new fibers (which costs a fortune).
Huber, who would leave Ciena in 1997 to found a competitor called Corvis, overcame these limitations by splitting the light into different wavelengths that could travel together down the same fiber. "You're adding virtual fibers, and virtual fibers carry real data," says Charles Fleckenstein, technology spokesman for Sprint, Ciena's first customer. "It's an inexpensive way to add tremendous amounts of capacity."
Ciena's first product, the MultiWave 1600, could send some 600,000 phone conversations along a fiber that previously handled 32,000 calls. (CoreStream, the newest addition to this product line, can transport the equivalent of 14.4 million calls along that fiber.) Ciena unveiled it in 1996, as telecom deregulation and Internet growth converged to fuel a frenzy of network construction. To keep up with demand, Ciena quintupled its staff, from 225 at the time of the February 1997 IPO to around 1,200 employees the following summer. That's when the Tellabs deal fell apart. For the first time in Ciena's brief and starry existence, the future didn't look so bright.
It is during tough times that a company's culture most affects its fortunes, and the man who embodies Ciena's culture is no stranger to hardship. Nettles, 57, greets visitors with a strong handshake, a mild Southern accent and a broad, friendly face. He was raised in Camden, a poor, rural Alabama town where he slaughtered hogs on his grandmother's farm and vowed to escape to greener economic pastures. This upbringing left Nettles with lessons that have served Ciena well. "My parents were products of the Depression, so I learned a fairly grounded view of money and finance," he says. "You definitely knew what living within your means is all about."
Nettles is known for being low-key, eschewing the brashness and arrogance often associated with corporate leaders. "In the early days, Pat would verbalize that he didn't want to be a patriarchal leader," recalls HR chief Rebecca Seidman. Ciena's managers, for instance, make decisions as a group, with department heads having the final say in most cases. A degree of modesty is expected of employees; kudos go to the group and bonuses are tied to team performance, not individual merit. "I can't think of a time when anybody actually verbalized that they were responsible for some success," says Seidman. "It's just not our culture." Prospective hires are carefully screened for these attributes. Say "I" too much and you probably won't get an offer.
The same values - modesty and collaboration - also apply to Ciena's business relationships. Most companies talk about "customer focus," but Ciena has a reputation for working closely with customers and delivering exactly what they need. "They don't come in, like so many vendors come in, and say, 'This is our product and it's gonna solve the problems of the world for ya,'" says Sprint's Fleckenstein. "They come in and find out what our specific problems are, and they're very good at that."
In a twist on teamwork, individuals bear the responsibility for failure. This has spawned Ciena-isms such as ONTG - one neck to grab. Marketing director Denny Bilter recalls bringing the company's first ad campaign to Nettles for approval. "Pat looked at it and said, 'You don't have to bring this to me. You're the expert. If it blows up, you're the one that's responsible.'"
Ciena's disdain for bureaucracy, employees say, is a big advantage. Give your people autonomy and you get back loyalty; the company lost less than 1 percent of its engineers after the Tellabs deal collapsed. Moreover, the absence of red tape permits the sort of speed and agility that helped Ciena win customers and rebound from the 1998 Tellabs fiasco.
Around that time, Ciena launched an ad campaign - the posters still hang in company cubicles - depicting the firm as a ravenous wolf bursting from a sheep's hide. In March 1999, Nettles demonstrated some lupine mettle of his own. He bet roughly a third of the company - nearly $1 billion - to acquire startups Omnia and Lightera, pushing Ciena into new markets. With rivals Nortel Networks and NEC gaining more control of the long-haul data transport niche where Ciena made its name, the battered firm needed to diversify.
The move was prescient; carrier spending is now moving from long-haul to optical switching, metropolitan networks and ultra-long-distance transport (routes longer than 372 miles). Not that the long-haul market is dead: The North American appetite for transport gear using multi-wavelength technology will grow from $6.4 billion this year to $10.1 billion in 2004, says research firm RHK; the strongest growth will be in the high-channel-count niche, a $1.6 billion submarket that Ciena led in 2000 with a 32 percent share.
By 1999, Ciena was moving aggressively into other optical markets. The company used Lightera's technology to create CoreDirector, an optical switch that lets carriers deliver precise amounts of bandwidth to customers and route long-distance traffic more efficiently. Introduced in late 1999, CoreDirector accounts for about half of the North American "optical core" switch market, which RHK predicts will balloon from $573 million this year to $4.5 billion in 2004. Tellium and Sycamore, the nearest competitors, each claim 19 percent of the market.
That same year, Ciena unveiled MultiWave Metro, its entry into the nearly $1 billion market for optical gear that moves data around urban areas. With a 21 percent market share, Ciena trails Nortel's 31 percent. But Ciena signed a deal in May with AT&T that boosts its position in this short-haul realm and should lead, analysts say, to AT&T purchases of other Ciena products.
Upgrades to Ciena's long-haul technology has also propelled the company into ultra-long-haul transport, a niche Nortel dominates. And in March, Ciena acquired Cyras for $2.6 billion in stock, gaining a switch called K2 that acts as a bridge between the older network infrastructure in metropolitan areas and the cutting-edge optical equipment that now resides in carriers' central switching facilities.
All telecom companies have been hit by the declining fortunes of equipment buyers, but Ciena has been hurt less than others. The key: Ciena shuns startup clients, focusing instead on established players that can pay their bills. It also refuses to lend money to customers, a practice that has backfired on rivals like Nortel, Lucent and Cisco, which have extended billions in order to win contracts; Lucent was recently stuck with a $600 million tab after Winstar defaulted on its loan. Similarly, unlike many smaller competitors, Ciena has never offered its customers an equity stake. "We're not venture capitalists," says CEO Gary Smith, who moved up from the COO job in May when Nettles stepped aside.
As wise as Ciena has been, it still faces some obstacles. Its two biggest customers - Sprint and Qwest - account for half of its sales. While that's not unusual for a midsize company, Ciena could get hurt if either of them were to slash orders; Qwest recently announced intentions to trim spending next year, but a spokesman says that won't affect its network plans.
Nortel, the global leader in optical transport, remains Ciena's biggest threat. Within months, it plans to ship HDX, its answer to CoreDirector. The new switch is a "Ciena killer," says Nortel spokesman Andy Lark. "Ciena's current position is the product of achieving first-mover advantage with a good product in a segment of the market, but first-mover advantage doesn't last forever."
Nor is Ciena immune from the overall downturn in telecom spending - it too has suffered from order delays and cancellations. Last October, RHK projected that the total North American optical transport market would reach $45 billion in 2004. In June, the researcher slashed its forecast to $34.9 billion. "The brutal answer is that you can't insulate yourself from something as macro as this," Smith says.
If that's true, it's Smith's job to make sure that any bumps are less turbulent than what the company faced in 1998. One reason Smith got the job was that Nettles had already achieved his goal of turning Ciena from a Wall Street whipping boy into one of the industry's few contemporary success stories. "To have a chief executive feel that way is a very dangerous thing," says Nettles. "I felt the leadership needed to be a little hungry."
Just like the wolf in the posters.
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