AT&T steps in with orders to cushion loss of Verizon

Ciena: Bye, baby; hello, Ma

Aug 27, 2001 @ 12:01 am

By Brooke Southall

A major telecommunications client is dropping Ciena Corp., two weeks after the once-hot telecom equipment maker was hammered in the stock market.

Industry sources confirm that Verizon Communications has stopped purchasing Ciena's metropolitan dense wavelength division multiplexing (DWDM) system in favor of a system built by Tellabs, a Lisle, Ill., competitor.

But there is no need to call 911 just yet.

Though Ciena may have lost a Baby Bell, it is dialing up big contracts with Ma Bell.

significant commitment

Telecom giant AT&T has recently made big, unpublicized orders for Ciena's "Core Director" optical switch, which moves data traffic to underutilized fiber-optic cables to boost capacity.

"AT&T just made a significant commitment to put Core Directors throughout their network," says Jack Harrington, general partner with Advanced Technology Ventures in Palo Alto, Calif.

Both developments come on the heels of the company cutting its earnings outlook through 2002, prompting Wall Street on Aug. 16 to send its stock tumbling more than 33% to about $18 from $29.

Nowhere were more brows furrowed over Ciena's revenues than in Boston. Fidelity Investments' mutual funds own a combined 15% of Ciena, or about 43 million shares, according to Thomson Financial.

Fidelity Advisor Technology A, Fidelity Select Technology and Fidelity Aggressive Growth have 6.22%, 4.9% and 6.34% of their assets, respectively, allocated to Ciena, according to Morningstar, the Chicago fund tracker.

Another 439 mutual funds own a combined 17% of the company.

But at least one mutual fund manager is smiling. Legg Mason star Bill Miller has been aggressively adding to his Tellabs position.

His $11 billion Legg Mason Value Trust fund now holds 3% of Tellabs' shares, having purchased 12.4 million shares since the beginning of the year, according to Morningstar's June update.

Ciena blew it by failing to meet Verizon's requests for customizations and not recognizing the New York company's decades-long ties to Tellabs, says Mark Lutkowitz, an analyst with Communications Industry Researchers in Charlottesville, Va., who also confirmed the loss of the business. "Ciena was really shocked," he says. "That's how quiet Tellabs has been."

hurting

Other regional Bell operating companies could follow suit, hurting Ciena's already weak sales projections. Once the news becomes widely known, the company's shares could be in for another pounding.

But thanks to AT&T, Ciena also could be one of the companies that leads a rally in the sector. The importance of the AT&T contract cannot be overstated, says Mr. Lutkowitz.

Not only may AT&T buy hundreds of the units, but it still has the biggest telecommunications network in the world. Any move it makes forces other service providers to follow suit and keep pace.

Ciena declined to comment on the AT&T contract.

Mr. Lutkowitz quotes a close industry source as saying that AT&T was seeking a device such as Core Director for its network.

Paban Pandey, a fiber-optics analyst for Murphy Investment Management in Half Moon Bay, Calif., says Core Director dominates because it reduces data to useable bits for end users. Competitive products do not attain such "granularity."

Mr. Lutkowitz adds that investors also should watch Ciena's largest customer, Sprint.

Sprint buys hundreds of millions of dollars worth of Ciena's DWDM systems every year to squeeze rivers of data into its networks. Sprint also buys Core Director units for its systems abroad, and it is satisfied with the performance of those switches, Mr. Lutkowitz says.

But thus far, the Kansas City, Mo.-based telecom provider has yet to add Core Director switches to its operations in the United States.

"Once Sprint starts using [Core Director] in the U.S., you're talking about serious, serious dollars," Mr. Lutkowitz says.

Still, Mr. Lutkowitz and Mr. Harrington say that they see short-term pitfalls for Ciena's shares because of "choppy" markets.

Last Monday, Lehman Brothers' Steven Levy downgraded the shares two notches, and Morgan Stanley's Alkesh Shah says that the shares could drop in half to $9.

In Ciena's most recent teleconference, company chairman Patrick H. Nettles said that his firm is trying to raise its metro DWDM business to 15% of revenues.

Fidelity may yet be rewarded for its outsized bets. This year, Ciena purchased Fremont, Calif.-based Cyras Systems for $2.6 billion

Mr. Pandey and Mr. Lutkowitz agree that Ciena can "piggyback" sales of the Cyras metro switch onto sales of its Core Director and ratchet up enough gains to allow Mr. Nettles to hit his 15% target.

There is a sweet irony for Mr. Nettles in his dealings with AT&T.

The last time Ciena's shares tanked in 1998, AT&T had just dumped the company, which caused Tellabs to back out of its deal to purchase the firm. The company's shares plummeted to $4.50 (by post-split calculations) before soaring to $168 a share during the tech stock boom.

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