Burnt Ciena

Sometimes, you really can find a silver lining in a cloud. But you won't find one in the failed Ciena/Tellabs merger. It's just an all-around ugly picture.

Ciena had a nice little deal to get itself acquired by Tellabs, one of the major players in the telecom market (well, if you consider $7 billion "little"). Tellabs was hoping to pick up Ciena's know-how in dense wave division multiplexing (DWDM), which lets carriers pack far more data onto optical fiber. [Get a dense wave division multiplexing tutorial]

But the two companies called off the mating dance last week under intense pressure from shareholders amid rapidly falling stock prices and lower earnings estimates. Ciena tried to put a positive spin on the collapse in a press release: "we remain excited about our future as an independent entity." The only problem: Ciena spent the previous four months loudly proclaiming how wonderful the Tellabs deal was and how the merger would keep it competitive - even as Ciena stock was sliding from the mid-$80 range to the mid $10s. [See Ciena's statement or Tellabs's]

Put it another way: Ciena looks a lot like the kid who just had his new birthday present stolen by the mean kid on the block; the baby who just lost its candy; the dog who just had its bone stolen (perhaps by that same mean kid on the block - the one who grew up to be a short seller on Wall Street).

To be fair, Ciena does have some things going for it: the company is ahead of the pack in DWDM, which some say will form the core of next-generation telecom networks, i.e., something the carriers are getting ready to spend big bucks on. The company does have some satisfied customers, $200 million in cash and a new OC-192 Multiwave Sentry DWDM system that will ramp up to a terabit/sec in two years. And the company has some strong management and sales staff.

And yet, the company also just announced a "cautious short-term outlook" due in large part to the same global slowdown that has rocked many other telecom vendors. And the recent fall from grace may be just what its rivals (far bigger companies such as Lucent and Alcatel) need to gain a lot of ground on it.

So what lessons can we take from this?

First, the stock market is a very fickle place and shareholders can - and occasionally do - scuttle even the best looking deals. Ciena really does need a major player like Tellabs to "take it to the next level." Telecom is a vast market - and it will take some hefty resources to conquer it.

The reality, however, is that investors have their own finances as their main concern, and not necessarily the technical or long-term merits of any proposed merger (let's not forget the short-sellers out there...).

Second, expectations can kill you. Ciena stock, much like that of many other technology companies, had been riding a tsunami of a market wave. Rumors surrounding Ciena as a takeover target had been circulating for quite some time, and market makers had been bidding up Ciena stock on speculation (and good quarterly financial results). But when the market slide began and Ciena began to hint of lower growth rates, these expectations were dashed and the result was a plummeting stock price that ultimately scuttled the deal.

Third, having all your eggs in one basket (or even just the perception of that) is not a good idea. Some 80% of Ciena's revenue comes from just two customers: Sprint and MCI WorldCom. So when AT&T announced it would not continue testing Ciena's technology, that meant a big hit for Ciena. That AT&T might turn around and work with arch-rival Lucent didn't help, either (in fact, the rumblings from the Ciena camp are that Lucent pushed AT&T to announce the end of the Ciena testing early to help scuttle the Tellabs deal).

Interestingly, Ciena wasn't even forcasting any revenue from AT&T for this year, and was projecting only a mere $50 million in 1999, something that still could come to pass as it is unlikely that AT&T will go with a single vendor for such a critical part of its network.

In any case, expecting Ciena, or any vendor for that matter, to dominate sales to all the top leaders in the US telecommunications market was a bit unrealistic to begin with. If nothing else, this should serve as a warning to wannabes everywhere that companies need a diversified customer base to thrive.

Given all this, don't be surprised if you see Ciena moving toward another merger or acquisition by early next year. Cisco, who already has a sales partnership agreement with Ciena, and which has a track record of snapping up promising start-ups, would make a great purchaser.

Interestingly, Cisco probably needs this as much as Ciena given the upcoming melding of DWDM technology with existing upper-layer products (i.e., switches and routers). If Cisco wants to aggressively compete with the likes of Nortel, Lucent and Alcatel in the telecom market, it will need much more than a sales relationship with Ciena - it will need to own this technology outright.

So while last week's news was not good for Ciena, it could still do well over the long haul. Things will likely get better and I wouldn't want to bet against them. The one caveat: Would Ciena's shareholders be willing to give the company some slack and forego immediate gratification for that long-term silver lining?