Ciena Corp: No Longer A Value Play

Includes: CIEN, CSCO
by: Ryan Barnes

Ciena Corp. (NASDAQ:CIEN) failed to get the Monday “Barron’s Bounce” after a bullish piece over the weekend. Monday was a rough day across the board, so it may have been simply too much to ask. But the value proposition for buying shares now escapes me nonetheless.

It highlights a dangerous trend that may pick up speed in the second half of the year. Microsoft (NASDAQ:MSFT) showed off its balance sheet and cash flows yesterday by announcing a $30 billion buyback, adding one more notch on the belt that could someday create the first technology bond proxy. But that’s Microsoft; very few companies could hope to match their cash-generating potential, even on the margin.

Balance Sheet Floundering

Ciena was presented as a value-based play, as the current assets are slightly more than the company’s $966m market cap. On a snapshot basis, that looks like value. But not when operating margins (which are less than 10% to begin with) have dropped over 250 basis points in the past 12 months, and the company is barely in the black.

It is treading water dangerously close to posting a new loss in the next few quarters, and the reality will hinge on capex trends amongst its major telecom customers. The balance sheet further erodes when you notice that goodwill has nearly doubled in the past year while current assets have dropped by over $500 million.

In this weak environment, it won’t matter if the company hits even a dollar (well above mean estimates) in net earnings for the current fiscal year; if a few announcements come out regarding lower capital expenditures for 2009, Ciena will trade on sales trends only, not valuations. While a return to 2000-2002 dynamics isn’t in store for the industry, Nortel (NT) did assume its historical place in line by drastically lowering estimates and having its stock price cut in half. The whole enterprise space deserves to be treated cautiously until we get some clarity into 2009.

Stick With Best In Breed if You Must Enter

If you really want to be in the sector, why not look towards Cisco Systems (NASDAQ:CSCO)? They’ve been super-diligent on costs -- preserving operating margins above 23% -- while generating double-digit sales increases across services and high-end hardware, and positioning themselves for continued emerging market growth.

They’re on pace to deliver over $12 billion in operating cash flow for the year, and shares can be picked up for about 15x current estimates. If tech becomes a place to hunt for value, this will be the place to start.

Disclosure: Author does not hold a position in the stocks mentioned.