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The Starting Line: Analysts squabble over Ciena prospects

Ciena looked immune to the economic slowdown--until last week when it cut its outlook for the rest of the fiscal year. Will it clip its guidance again?

Ciena is either a telecommunications-equipment maker that has merely hit a speed bump in a rough market or a company that's likely to see more tough times ahead. For Wall Street analysts, there's no in-between.

And it's a debate you'll be hearing for a while. Ciena was among the last holdouts in the telecom gear market. It looked immune to the economic slowdown, delivering good earnings as rivals posted losses and announced layoffs. That changed last week when the company cut its outlook for the rest of the fiscal year.

Now the big question is whether that outlook will be cut again. What a difference a week makes. Ciena makes next-generation fiber-optic equipment that was the rage as telecom customers looked to cut network costs. It was a sweet spot that awarded Ciena shares with a nice premium compared with its peers--until the floor fell out from under them.

Ciena posted strong third-quarter results but cut its earnings outlook for the current fiscal year, saying it now expects to report an adjusted earnings-per-share figure between 59 cents and 64 cents, with 2002 earnings essentially the same. Revenue growth will also be slower than expected.

"In 2002, revenue should grow in the early teens," CEO Gary Smith said, which is lower than previously forecast but "still a healthy growth rate in light of enormous market uncertainty."
Investors didn't think that rate of growth was too healthy and sold Ciena shares for three consecutive days. Analysts also lowered estimates and cringed at the outlook--especially since many on Wall Street had "buy" ratings.

For its part, Ciena remained upbeat. It said it is facing a difficult market but remains in a better position than its peers. Smith also noted that Ciena is still hiring new workers, a move some analysts questioned especially if the market continues to get worse.

Outlook for Ciena's gear
Ciena counts long-distance carriers, competitive and incumbent local exchange carriers, ISPs, and wireless and wholesale carriers as its customers. Here's a look at its target markets and products:

Long-haul transport (MultiWave CoreStream, MultiWave Sentry): The company expects to maintain market share with 10-gigabit and ultra-long-haul features. Sales should be down in the fourth quarter and flat to down in fiscal 2002.

Metro switching (MultiWave CoreDirector, MultiWave MetroDirector): The K2 platform could be in the hands of 10 customers by the end of the fourth quarter and could generate initial revenue. CoreDirector is expected to account for at least a quarter of fiscal 2002 sales.

Metro transport: Ciena is working on the integration of its metro switching and transport products, which it believes will be a critical differentiator. The combination of metro switching and transport could be 15% of revenue in fiscal 2002.

Sources: Ciena, Wit SoundView

Ciena's latest blow came Monday after Lehman Brothers' Steven Levy checked in with an admittedly late downgrade of the stock. He cut it to "market perform" from "strong buy."

"Even after a precipitous decline in the share price, we do not see the shares providing any reasonable return for at least the next six months and believe further downside is possible," Levy said.

The crux of Levy's argument is that a bet on Ciena is too risky right now. Leading up to Ciena's earnings report, it was assumed that the company had clear visibility to its future orders. Smith shot that down on the conference call, noting that visibility into 2002 remains low.

"The bottom line is that the outlook for Ciena has changed dramatically in an extremely short period of time," said Levy, who added that the company could cut its outlook again if telecommunication spending weakens.

Levy, along with other analysts, argued Ciena shares should trade at about $15 or so. Morgan Stanley's Alkesh Shah said Ciena shares could have "downside to $9." Ciena shares closed Monday at $18.09, down 3.67 percent.

Balance sheet raises eyebrows
Analysts who are predicting trouble ahead for Ciena used the company's balance sheet to bolster their arguments.

For starters, Ciena's days sales outstanding (DSOs), a measure of how quickly a company gets paid, rose to 73 days in the June quarter from 57 days in the previous quarter.

Shah said the rise in DSOs may "signal the use of more attractive financing terms to entice North American customers."

The company also said DSOs could rise in the current quarter before retreating to normal 70- to 90-day levels.

Meanwhile, Ciena also saw inventory rise $30.6 million to $306.6 million, despite a $31.1 million inventory write-off.

"Changes such as this in a company's balance sheets are not reassuring, especially as the business fundamentals begin to deteriorate, and we plan to watch this metric carefully over the next few quarters," Levy said.

Other analysts downplayed the balance-sheet worries. They point out that Ciena DSOs may be up because the company is selling more to international carriers, which historically take longer to settle bills.

Nikos Theodosopoulos, an analyst with UBS Warburg, said Ciena's balance sheet "degraded slightly," and noted that the company ended its third quarter with more than $1 billion in cash and short-term investments.

Supporters hold out hope
Despite the concern about Ciena, many analysts remain firmly in the company's corner.

Tsvetan Kintisheff, an analyst with Kintisheff Research, told his clients to buy shares of Ciena even as other investors were bailing.

Those who support the company note that Ciena has the best house in a bad neighborhood and has been able to execute better than other companies. They add that Ciena had an upbeat outlook for its CoreDirector product, an optical switch.

Smith said CoreDirector will account for 25 percent to 35 percent of the company's revenue for 2002, implying a 110 percent year-over-year growth rate.

While acknowledging that Ciena's sales of long-haul transport products will fall, analysts remained upbeat that the company's focus on next-generation equipment will pay off. Indeed, Ciena has the market-share lead in the long-haul DWDM (dense wavelength division multiplexing) market, according to Dell'Oro Group.

Theodosopoulos, who has rated Ciena "hold" since April, when shares were trading at $60, said the company's stock is likely to run in place for three to four months or until there's some concrete outlook for the industry.

And if Ciena shares continue to fall, Theodosopoulos said the company could become a takeover target for Cisco Systems.

But none of those reasons will get an upgrade out of Theodosopoulos. He admits to being tempted to upgrade Ciena "because shares are down a lot," but he remains wary of telecom spending.

"The company is clearly executing well and they have some new products, but you have to wait for some positive fundamentals," he said.