CIEN: RAISING PRICE TARGET TO $36; RECENT NEWS THAT CIENA WILL REMAIN THE
EXCLUSIVE SUPPLIER TO SPRINT IMPROVES OUR CONFIDENCE IN THE STORY
Subject: Ciena Corp. (CIEN-28 1/4)--OTC
TELECM EQUIP
OPINION
Current: ACCUMULATE
Analysts: John H. Butler (212) 778-1488 Prior:
Jason Paraschac (212) 778-2808 Risk: HIGH
12-Month Price Target: $36
Ind. Div.: - Yield: - Shares: 107.8 mil. 52-Wk.Range: 92-8
EPS FY Year P/E 1Q 2Q 3Q 4Q
Actual 10/98 $ 0.78 36.2X $ 0.37 $ 0.29 $ 0.15 ($ 0.03)
Current 10/99 $ 0.26E 108.7X $ 0.02A $ 0.03E $ 0.08E $ 0.13E
Current 10/00 $ 0.72E 39.2X $ 0.10E $ 0.16E $ 0.22E $ 0.25E
Recent good news from Sprint boosts our confidence in the long-term outlook for
Ciena. Sprint remains Ciena's biggest customer and on Wednesday, February 25th a
Baltimore newspaper reported that Ciena will remain the exclusive supplier of DWDM
equipment to Sprint throughout 1999. We subsequently confirmed this news with
Ciena. For several months, Sprint has been threatening to choose a second source
vendor for DWDM equipment which, we believe, created a bit of an overhang on the
stock. But given this latest news, together with Ciena's strong F1Q99 earnings
reported last week, we believe that investor sentiment on the stock, as well as our
confidence in the story, continues to improve. As a result, we are raising our
price target on shares of Ciena from $26 to $36.
We are raising our price target on Ciena to $36 based on improving visibility and
rising investor sentiment. Our new 12-month price target is based on a multiple of
45 times our calendar year 2000 EPS estimate of $0.80. This multiple represents a
10% premium to Ciena's historical average forward 12-month P/E of 41. We derived
this average over the period extending from February 21, 1997 through to the
announcement of Ciena's proposed merger with Tellabs which was June 3, 1998. Our
current price target multiple represents a 10% premium to this historical average.
We believe this premium is reasonable for three reasons. First, Ciena is in the
early stages of recovering from a period of softness. As a result, we believe that
there is upside potential to our calendar 2000 estimates based on the potential for
the company to add new customers and/or restore its margin back to the 40% to 45%
range sooner-than-expected. Second, Ciena continues to maintain a leadership
position in this high-growth industry segment. As a result, we are confident in the
company's ability to build its share of this market over the next 12 to 18 months.
Finally, it is important to note that several recent positive announcements have
re-ignited significant investor interest in this stock. We believe that this
increase in investor confidence, together with the potential for Ciena to make
further strides in improving its financial performance should continue to fuel the
stock higher from current levels.
We are maintaining our Accumulate due to the potential for near-term volatility in
Ciena's stock. Although our new price target reflects 27% upside from current
levels, we are maintaining an Accumulate rating on the stock, as opposed to raising
to a Strong Buy. Our decision is based on the continued risk of significant
near-term volatility in Ciena's stock as it continues to rebuild its business. We
also suspect that the near-term risk of a correction remains high, particularly if
takeover speculation on Ciena begins to cool. Although Ciena remains an attractive
take-over candidate, we believe it is more likely that Ciena makes a strategic
acquisition in order to flesh out its product line or strengthen its R&D effort.
We are going to maintain our estimates for now, despite our suspicion that our
long-range margin assumptions may prove to be too conservative. On the heels of
reporting stronger-than-expected F1Q99 results, we raised our FY99 and FY00 margin
assumptions on Ciena by 80 and 64 basis points, respectively. We believe that the
significant pricing pressure Ciena experienced in the latter half of 1998 has now
begun to subside. In our view, the pricing pressure Ciena experienced in the second
half of '98 was generated by competitors marketing products that were not quite
ready for commercial deployment. To our knowledge, Ciena remains the only vendor
shipping a 40-channel DWDM system and by the second half of the year, the company is
expected to begin shipping its new 96-channel system. We suspect that this latest
news out of Sprint is reflective of the fact that Ciena continues to lead its
competitors in terms of its ability to deliver the highest channel count system on
the market. We note that Sprint had been testing several competitors' products in
its lab. As a result, we are inclined to believe that our assumptions in regard to
future price declines for DWDM equipment may be too aggressive. This, in turn,
could lend upside to our margin estimates. Until we gain better visibility on the
long term margin trends, however, we prefer to maintain our current assumptions.
We believe Ciena represents an excellent long-term play in the optical networking
group. For those investors with a long-term investment horizon and the ability to
stomach high volatility, we believe Ciena represents an excellent long term play in
the optical networking space. As stated above, we expect continued volatility in the
stock, and would not be surprised to see Ciena correct from current levels in the
near future if the current takeover speculation dies down. For the long term
however, we continue to have a high degree of confidence in Ciena's ability to
execute on its plan. As a result, we reiterate our Accumulate rating on the shares
of Ciena with a 12-month price target of $36.
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