It would probably be an understatement to say that it has been a difficult earnings season for companies selling into the telco service providers. After hopes of a second half recovery in 2012 were dashed by a second half slowdown the idea was that pick-up would be pushed into 2013. So far it hasn’t worked out like that. Indeed a host of companies have warned and lowered guidance and even companies who don’t exclusively service the sector like Fortinet Inc (NASDAQ:FTNT) or F5 Networks, Inc. (NASDAQ:FFIV) have cited specific weakness from their service provider verticals.
With that said, what is the market to make of the recent sterling results from Ciena Corporation (NASDAQ:CIEN)? Does its earnings beat and guidance raise mean that telco spending is back?
Is it the industry or is it Ciena?
Answering this question requires an understanding of where the industry and Ciena has come from. My view is that it is more about Ciena than being a general signal that telco spending has recovered. On the evidence so far, the indications are that telco spending is weaker but Ciena is benefiting from some favorable trends in the industry. Investors in the industry would be well advised to try and stay stock specific.
I discussed Ciena Corporation (NASDAQ:CIEN) in an article earlier this year linked here, and many of the markers that they company laid out then came into fruition in the latest set of results. Therefore these results were really a continuation of positive trends identified by the company. For example in the last conference call it outlined that its Q1 was back-end loaded and Q4 had seen record orders. Clearly that momentum continued into Q2. In addition the product mix is getting better for gross margins too. Its lower margin solutions are in optical transport, and they dropped as a share of revenues from 17.7% to 11.3% in Q1 as overall revenues rose 6.3%. Meanwhile its gross margins improved to 41.2% from 38.2%, and it believes it can hit mid-40’s margins in the future.
What is going right?
The key to the results is that the service providers are expanding expenditures on newer technologies like 40G and 100G high speed Ethernet networking and Optical Transport Networks (OTN). The share of Ciena Corporation (NASDAQ:CIEN)’s revenues from 40G and 100G rose to 70% from 60% in the previous quarter. Meanwhile its management spoke to 100G and OTN spending being in the first to second innings of a multi-year expansion.
Essentially telcos are having to adjust to huge growth in areas like cloud computing and mobility, which are creating huge increases in data volumes. Furthermore as the switch to wireless from wireline spending gathers apace and 4G/LTE rollouts increase we can only expect more of this. The question is this; if all these issues are coming together then why hasn’t overall telco spending strengthened?
I’ve discussed the capital expenditure plans of AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ) in specific articles linked here and here. With regards to AT&T, it disappointed the industry by announcing that its capital spending plans for 2014 & 2015 would be cut by $2 billion respectively so they would now lie at around $20 billion in each year. This sounds like bad news but it was because it got better deployment from its current 4G/LTE rollout and was actually ahead of its plans to deploy 300 million 4G/LTE points of presence by 2014. Again it outlined its shift in spending towards high bandwidth capability and corporate mobility. Good news for Ciena, not so good for legacy technology providers.