CIENA and Bookham: A Good Match?

CIENA Corp. (CIEN) looks undervalued with about $11 a share cash on hand, and trades at about the same price.  The company has a book value of  $11.28 a share, trades at a forward P/E ratio of 15.5 and trades at 1x sales.

11 analysts cover CIEN with price targets that range from $12 to $24 a share with an average target of $15.

CIEN could be in the acquisition market, and with a large amount of cash on hand, Bookham Inc. (BKHM) is the first idea that comes to mind. CIEN recently picked BKHM  for its tunable universal transceiver products. 

James Zik, senior product marketing manager at Ciena said:

We made the decision to use this next-generation footprint tunable pluggable module for our 10Gb/s transmission to provide our customers superior shelf density, pay-as-you-grow optical scalability and reduced hardware sparing.

The Bookham product offers Ciena the ability to achieve flexible, multi-reach 10Gb/s integration with removable line-side optics for enhanced service ability at lower cost points, as well as the ability to incorporate unforeseen future enhancements on a per-channel basis.

Looking at the balance sheet, BKHM has zero debt, and trades well below its book value of $1.49, which makes it more of a value play than others in the sector. BKHM is undervalued, trading with a Forward P/E of 18 and just 0.4x sales with a growth rate of 39%. The growth rate is almost four times that of JDS Uniphase (JDSU), and twice that of Finisar Corp. (FNSR), which was my favorite in the group. But now, BKHM, at the current stock price of $1.18, is far too good of a bargain to pass up.

BKHM is a take over candidate with $50 million cash on hand, debt free and just 101MM shares outstanding. Some players in this space could easily offer 2x book  or about $3 a share.

Six analysts cover BKHM and have targets from $2 to $4. The most recent analyst is Paul Bonenfant at Morgan Keegan, who started coverage on 7/16/2008 with an outperform rating and $3 target. Bonenfant said the company continues to benefit from an expanding customer base, and its timing of new product introductions.

At the time he initiated coverage, BKHM was trading at around $1.70 per share, which is nearly 45% above the current price.

Disclosure: No position in JDSU. Long FNSR. Adding new positions in BKHM and CIEN.

Comments

[Andrew Schmitt:]

You clearly don't understand how this business works.

The last thing an equipment company wants is an optical company.

2008 Sep 22 08:48 AM

[LT777:]

I'll clearly admit I don't know the slightest thing about how this business works...but can you explain why "The last thing an equipment company wants is an optical company."?

If Ciena, which makes network infrastructure hardware (among other things), and optical/wireless/wifi/... is the next wave, why wouldn't they want to buy a (cheap) company in this space?

2008 Sep 22 09:35 AM

[numinary:]

reasons to be cautious on BKHM:
-13.7% operating margin (ttm)
only 50mm in cash with -39mm levered free cash flow (ttm)
major >10% customer is Nortel who is selling off their optical business
major customer is Ciena who pre-announced weak sales

reasons to be bullish on BKHM:
amount of money lost each quarter getting smaller
some interesting product announcements

reasons why a systems company is unlikely to buy an optical company
a) systems companies all spun out their optical subsidiaries pre-bubble or during the telecom bubble
b) premise is to "realize public value" of these businesses
c) additional premise is to allow optical companies to sell to many different system vendors & carriers and therefore address a larger market. if the optical company is in-house then they can typically only sell to the in-house customer and not external
d) Ciena would rather buy from many suppliers than support the R&D for an in-house optics team

2008 Sep 22 11:03 AM

[Nom De Plum:]

Agree with Schmitt on this one. The advantage to being an OEM is you can play one desperate component/module player off of another to improve your margins. There is no reason that CIEN would buy BKHM. What would would happen to any revenue that BKHM sells to CIEN competitors. Likewise, the advantage to being an operator is you can one OEM off another to improve your own margins. Fortunately, CIEN has the staying power (cash) and R&D prowess of remianing relevant cycle after cycle. CIEN maybe not a bad pick here, but BKHM is burning cash. Your only hope with BKHM is a takeout which has been rumored for over 5 years.

2008 Sep 22 11:32 AM

[tommybwahahama:]

yeah, yeah, heard it all before. GLW was supposed to be dead too. i still think it's just a matter of time before the FO sector comes roaring back. main concern is how much longer?

i've been impressed with bkhm's product development.

2008 Sep 23 05:46 AM

[Andrew Schmitt:]

Sorry for being flip. Nom de Plum described it well. Unless vertical integration results in a unique benefit (like Infinera) then it is of no value in the existing competitive environment.

2008 Sep 23 08:37 AM