TSC/Petrie. Ciena's Problems Started Long Ago
thestreet.com
By Kevin Petrie
Staff Reporter
8/21/98 12:10 PM ET
Wall Street decided a week ago that Ciena (CIEN:Nasdaq)
is more of an also-ran than a technology pioneer, but the
scent of the Maryland company's troubles has been in the
wind for months.
Last Friday the supplier of optical fiber gear for
telecommunications companies warned Wall Street that its
fiscal third-quarter earnings would fall well short of
expectations because orders were delayed and it had to cut
prices for at least one customer. Its stock plunged 24%.
Today, the news got even worse as a giant in the industry
said it won't buy Ciena products, quite possibly scuppering
the deal that was to save Ciena.
But in reality, Ciena's tight grip on its market had loosened
gradually over the past year. Most of the signs were subtle,
such as small phone carriers choosing products made by
Ciena's competitors. At the time, even a February profit
warning looked innocuous because Ciena said just one
customer, WorldCom (WCOM:Nasdaq), had backed away
from orders. Ciena mentioned no competitive threat, and
words of caution from a few brave analysts were lost in the
chorus of cheers for a company that in six years had forged
a powerful new niche in networking. Ciena had chalked up
$500 million in annual revenues and made investors rich
along the way.
What the subtle signs really pointed to was that competitors
had multiplied in dense wavelength division multiplexing or
DWDM, a technology that telephone companies use to pack
extra channels of traffic into their optical-fiber networks.
While telephone carriers often use two suppliers for one
product, their selection of alternatives to Ciena has been far
more jarring than investors expected. Interviews with
customers suggest that Ciena lost some contracts because
its competitors were able to sell a wider array of technology.
So Ciena was forced to slash prices to fight back,
something it disclosed last week.
These changes underscore the need for Ciena to join with
Tellabs (TLAB:Nasdaq). But Ciena's warning of terrible
profits last week cast doubts on just what Tellabs is buying.
And the news this morning that AT&T (T:NYSE) won't test
Ciena products in the future made the would-be merger
partners put off their shareholder-approval meetings today
and got the stocks of both companies halted. Ciena
promised further explanation today and the vote was pushed
back to Sept. 9.
Ciena's warning last week "shouldn't be surprising to
everyone," says Kevin Kalkhoven, chief executive of
Uniphase (UNPH:Nasdaq), a supplier to Ciena and other
DWDM companies. Kalkhoven says numerous vendors,
including Pirelli and Alcatel (ALA:NYSE ADR), drove home
the strength of their own products at an Atlanta trade show
this spring.
Northern Telecom (NT:NYSE) landed a DWDM contract
with Williams Communications (WMB:NYSE) as long ago
as two years because its units, while operating with only
eight channels, fit the extra-wide pipes on Williams' network.
Nortel also had complementary products for Williams. Ciena
had neither.
Wayne Price, a senior network manager for Williams, says
his company is testing units from both Ciena and Pirelli for a
more narrow use on its network, but Pirelli's presence in the
tests again shows that Ciena is no longer alone.
"The list [of suppliers] has grown since we started looking at
this stuff," Price says.
As a specialty supplier, Ciena was restricted partly by its
lack of complementary network products. In February 1997,
the carrier Frontier (FRO:NYSE) bought 16-channel units
from NEC (NIPNY:Nasdaq ADR) rather than Ciena because
NEC also had products based on a standard called
synchronous optical network, or Sonet. Ciena doesn't sell
Sonet gear, although Tellabs does.
"We decided to go with one vendor who had both systems,"
says a Frontier spokeswoman. Frontier will test larger
DWDM products from about six suppliers, likely including
Ciena, later this year.
Then came the big blow. AT&T disclosed last week that it is
activating 16-channel DWDM products from Lucent
(LU:NYSE) on its network. Ciena did not pass AT&T's test,
losing a big business opportunity with its first generation of
products. It is the first time that investors' fears of
competition from Lucent, an AT&T spinoff, were realized.
One thing that happened is that DWDM technology aged
faster than many expected. Kalkhoven at Uniphase says
DWDM suppliers are leapfrogging to the next generation of
products much as the PC business shifted rapidly from the
386 to more powerful microprocessors. One generation of
technology might pass in 18 months, Kalkhoven says,
quickly changing the market's winners and losers.
All of this led Ciena to make steep price concessions to at
least one large, unnamed customer last quarter, which
raises questions about the premium value of DWDM. Many
investors were surprised at the quick onset of price
competition. And it's always tough to push prices back up,
especially in the technology field.
A few analysts predicted Ciena's problems. In January, Tim
Savageaux, then at BancAmerica Robertson Stephens,
opened coverage of Ciena with a meager long-term attractive
rating. Robbie Stephens was not a Ciena underwriter.
"Our view had always been that there are at least a
half-dozen big, angry suppliers," Savageaux says. So Ciena
was running a horse race. Savageaux hasn't covered the
stock officially since jumping to Volpe Brown Whelan in
June.
Kevin Slocum of SoundView rang the bell just in time,
chopping Ciena and Tellabs to hold ratings three weeks ago
on worries including price competition and the risk of losing
AT&T's future business. SoundView was not an underwriter
for Ciena.
For its part, Ciena says it has kept its edge even while the
field grows crowded. A company spokesman says Ciena
shipped 16-channel products before the competition and is
swiftly developing future generations of DWDM technology.
The company believes cutting prices is a justified means of
winning big contracts, and that its focus on DWDM helps
large phone carriers select the very best technology rather
than buy all their products from one vendor. Moreover, the
spokesman adds that by selling to Tellabs the companies
will broaden their offerings.
One step toward making premium systems is building
something called an optical switch along with DWDM
products. An optical switch flashes light signals across
networks without converting them back into slow electronic
pulses along the way. Several companies, likely including
Ciena and Tellabs, are developing such a product.
Meanwhile, WorldCom, the first big customer that suggested
Ciena may be stumbling, said in February that Ciena
"remains our DWDM supplier of choice." But now even that's
unclear. WorldCom can't seem to decide what to do with
Ciena. The Wall Street Journal, citing WorldCom officials,
reported last week that there is "uncertainty" about future
sales with WorldCom. WorldCom then declined to comment
this week. For its part, Ciena says it expects WorldCom to
buy its products in the future.
But investors now are skeptical about such statements
rather than lovelorn. |
