Ciena Plunges as Dilution Worry Overshadows Product Gain

The good old days when investors cheered acquisitions are gone, even in optical networking.
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Ciena

(CIEN) - Get Report

is nothing if not bold.

Slippery Slope
Ciena's two-day slide

Seeking to plug a gaping product hole, the optical networking firm Tuesday set a

$2.6 billion acquisition of closely held upstart

Cyras

. Ciena expects to boost its fortunes by building its technology roster in the hypercompetitive and lucrative metro area, or edge-of-network, Internet equipment business, where competitors appear to be off-balance right now.

But the Cyras deal could disorient Ciena just as easily. The merger will reduce Ciena's earnings by as much as a third next year, and investors have been paying up in recent months for little else. Meanwhile, despite its important market niche, Cyras boasts no revenue, no immediately marketable product and a two-year run of setbacks including an IPO that never materialized. Investors, increasingly risk-averse when it comes to stocks with triple-digit P/E ratios, chased Ciena shares down 22%, to $75.

I Want My WDM

Ciena insists that Tuesday's hit to its greatest asset in recent times, its richly priced acquisition currency, is worth it in the long term. "Obviously you would choose better market timing if you could," Ciena's CEO Patrick Nettles said in an interview Tuesday. But customers want a metro product now, says Nettles, and there would be too much to lose without it. "If we waited longer we would have lost momentum and potentially have lost some footprint," said Nettles, referring to Cyras's presumed fit in the emerging demand for metro networking gear.

Still the One
Ciena outperforming Nasdaq

Cyras makes what is known as second-generation synchronous optical network, or SONET, devices that bridge the old world phone networks to the new world optical Internet. Most urban communications networks were built on what's known as a SONET ring structure, a setup now seen as cumbersome because it requires duplicate fiber-optic pathways for all traffic. As SONET gives way to more efficient network designs -- such as wave-division multiplexing, or WDM, which boosts capacity by splitting lightwaves -- network builders have been on the hunt for gear that can ramp SONET-based traffic onto more modern packet-based networks.

Cisco's

(CSCO) - Get Report

$6.9 billion acquisition of

Cerent

last year fit precisely this strategy, as did

Redback's

(RBAK)

$4.3 billion buy of

Siara

.

What Price Metro?

In tech merger

calculus, Cisco paid a whopping $24 million per employee for Cerent, more than double the $10 million Ciena will pay for Cyras. But the return on Cisco's Cerent investment appears poised to kick in, just a year later: Cisco expects to show $1 billion in calendar 2000 revenue on the Cerent box.

Meanwhile, Cyras hopes to cash in on what some analysts see as the pent-up demand for these devices, caused by a reported delay in delivery of the second-generation Cerent box. Ciena's Coredirector optical switch has a limited reach into the edge of the network, where traffic originates. Analysts say Cyras' device could sit next to Ciena's gear and open a spigot of metro traffic into Ciena's core equipment.

Yet for investors who want to know if the Cyras box will fly, Ciena was a little vague.

Nettles said he'll reveal in mid-February on a conference call with analysts whether Cyras sales will contribute to next year's revenue. In the meantime, he said the Cyras product will be commercially available in the first half of next year. Nettles also said Cyras has its K2 metro switching product in four trials with major telcos.

"We haven't been part of the selling process, so it's hard for us to gauge when that converts to revenue," said Nettles. "I am optimistic about this combination, but I don't want to get ahead of myself in terms of making forecasts."

Back to the Timing

How times have changed. It was only a few months ago when investors didn't care about such forecasts. Pricey acquisitions of beta-version networking equipment sent investors rushing to buy shares of the acquirers, on the reasoning that increased product reach translated into potential market dominance. Now, the unknowns simply pile up as risk factors.

In that vein, Cyras had the unfortunate timing of running up to an IPO just as the IPO market collapsed this summer. Shortly thereafter, CEO Steve Pearse resigned, and last month Ronald Kelley, Cyras' head of North American sales, quit.

In a way, this turmoil may have worked in Ciena's favor, bringing down the price. Still, even a cheap deal carries risks, especially since Cyras' 264-employee Fremont, Calif., operation is more than 3,000 miles away from Ciena's Linthicum, Md., headquarters.

After all, bicoastal tech marriages are fraught with challenges. For instance,

Lucent's

(LU)

acquisition of

Ascend

proved to be a office-clearing fiasco, say industry observers and Ascend insiders who say few of Ascend's choice employees stuck around after their options vested.

Ciena says it expects Cyras' sales will contribute to earnings by the second half of 2002. Of course, that assumes everything works out favorably. Jittery investors have already shown they assume otherwise.