Ciena Rides Optical Networking Highway Unhindered, Unlike Nortel

SAN FRANCISCO -- The future begins now for networking companies, which is bad for Nortel NT and good for Ciena CIEN, judging by Thursday's action.

Its little-discussed old-school phone business appeared Thursday to have been Nortel's undoing, which could mean further bad tidings for the big phone gear makers and good cheer for Ciena and its brethren, such as Sycamore SCMR and Corvis CORV. Meanwhile, Ciena's bullish comments had investors rushing headlong into the networking sector throughout Thursday.

The thread tying the events together is the so-called optical revolution in networking equipment. Ciena is the leader among companies focusing purely on optical networking, a leading-edge protocol that uses lightwaves to haul information over fiber optic pathways, and has gained significant headway in sales to optical buyers. Nortel, meanwhile, sells optical gear along with traditional telephone gear, the electronic, voice-based equipment that networks have sought to replace with optical systems that carry voice and data traffic on the same pathway. And weakness in that so-called legacy business has punished Nortel the most in its current quarter, it appears.

Bookends

Ciena kicked Thursday off with a strong earnings report that sparked a rally across the networking sector. Despite the slouching economy and the cash-hoarding quest-for-survival among many phone and Net service providers, Ciena managed to turn on the steam in sales and profits for its first quarter while pointing to even better times ahead. Its stock soared $12.19, or 16%, to $89.

Nortel, by contrast, shocked investors by forecasting a lingering industrywide slowdown and an accompanying deep shortfall in earnings and revenue growth. After hours, its shares plunged 22%, leading to a pullback in the networkers that had run up during the day.

"It looks like the theory is starting to bear out -- the old, staid companies like Nortel and Lucent LU are having troubles and turning into the IBMs of the networking industry," says Tim Kristiansen, a money manager with Carnegie Asset Management of Copenhagen, Denmark. "Then you have newer companies like Ciena winning away the business." He owns no Ciena or Nortel, but does own Cisco CSCO.

Mirage

Nortel had convinced itself that growth would continue north of 30% annually, and that any economic slowdown would dissipate in a second-half recovery. But the company's comments in a postclose conference call struck a blow at the viability of the bounceback scenario recently favored by the likes of Cisco and JDS Uniphase JDSU.

CEO John Roth was asked why the company, on three separate occasions, stuck with its optimistic guidance even as evidence of a slowdown mounted. Roth said Nortel had "good visibility on the carriers' budgets," but one-by-one the big telecom carriers began reviewing each dollar they were going to spend. "This is a process we'd never seen before," he said on the conference call, which ironically suffered transmission difficulties due presumably to overloaded phone circuits.

Roth conceded that the overall climate has changed considerably. The limp U.S. economy combined with the heavy debts and limited cash held by phone companies combined to dramatically slow industry equipment spending. At least that's how Nortel experienced it.

"The carriers are nervous, they want to make sure every dollar they spend generates revenue this year," Roth said. "I don't see any relief from that. By the end of January we thought they would resume their normal business practice."

Sunny Side Up

Meanwhile, all was sweetness and light in Ciena's camp. Ciena's president and chief operating officer, Gary Smith, said in an interview after the company's conference call that the ill winds that blow across the sector are actually at Ciena's back.

"We've long talked about a shift from legacy [old electronic-based phone gear] to new optical data networks," said Smith. "And while we certainly aren't immune from the impact" of larger economic and network equipment spending slowdowns, "because of our product portfolio, we are beneficiaries, in a perverse way," of that shift in spending.

Speaking to a related issue, Nortel Chief Operating Officer Clarence Chandran was asked if Ciena was taking optical market share away from Nortel. Chandran said no. But investors will surely draw their own conclusions.