Recently, the world's greatest speculator, George Soros, initiated a new buy into one mid-cap stock, Ciena Corporation (NYSE:CIEN). Actually, following GuruFocus data, Soros had been familiar with this stock since 2008. Some of the CIEN trades were profitable, and others realized a loss. For this year, his fund initiated a small long position since the first quarter of 2011 for am average price of $25 per share, then added significant amount for $11.24 and sold out the entire position in the third quarter for nearly $14 per share.
The buy was going against the massive insider trading which just happened within December as well. Different executives in the management team, from the president, CEO and CFO, to chief technology and senior vice president and general counsel have kept selling a significant number of shares out for the range of $11-$12 per share.
In terms of the business overview, CIEN is the provider of equipment, software and service solution to support transport, switching, aggregation and management of voice, video and data traffic on communication networks. It has four main operating segments: Packet-optical support, Packet-Optical Switching, Carrier Ethernet Solutions, and Software and Services. Historically, the main revenue driver comes from Packet-Optical Support, making up more than half of the total sales, then the Software Services segment, making up nearly 20% of the total top line for the year 2010 and 2011. A sizable portion of CIEN’s sales are coming from sales to a small number of service providers, especially within the Packet-Optical Switching and Carrier-Ethernet Solutions where four customers jointly accounted for more than 65% of the revenue in fiscal 2011. One of the big customers was AT&T (NYSE:T), who had contributed 21.6% of total sales in 2010 and 15.5% in fiscal 2011.
Historically, the operating performance of CIEN does not look very intriguing for value investors. The top line was fluctuating on the rising trend, and the sudden 100% jump in the 2010 fiscal year was due to the acquisition of substantially all of the optical networking and Carrier Ethernet assets of Nortel’s Metro Ethernet Networks business (the “MEN Business”). Along with that, the operating income and the net income was deep into the negative figures for the most part of the 10- year history.
The same messy figures were spotted in the cash flow generation, in both operating cash flow and the free cash flow of CIEN.
So as for value investors, CIEN is definitely not the good stock to buy and own for the long-term when the technology and the firm got the history of burning cash and generating losses overtime. So how about its assets?
Not only does the income statement and cash flow situation looks messy, but also the financial structure. CIEN has $14 million in total shareholders equity and nearly $2 billion in total liabilities, including nearly $1.45 billion in long-term debt. The gradually reducing value in equity figure is because of the accumulated loss over time, and the debt taking into the MEN acquisition in 2010. In the asset side, the good thing to see is the high level of cash, at the amount of $540 million, equivalent of 27.8% of the total assets. With the extremely high leverage structure, if something goes wrong in the business such as a big customer terminating the relationship, it would totally wipe off the very thin equity which has been eroded over time since 2002.
In terms of the communication networking industry, that the big customer AT&T has chosen CIEN as one of the domain suppliers within optical networking proves the ability of CIEN on that field. In addition, the “MEN” acquisition was critical for the economies of scales to compete with big competitors such as Alcatel-Lucent (NYSE:ALU) and Huawei (SHE:002502). The acquisition was supported on the thesis that demand for streaming video would continue to be the boom over the next several years, and that would drive the demand for optical networking equipment. However, the competitors would fight into the market. Competitors such as Huawei and ZTE seem to accept bad margins in the short-term to gain the market share for the long-term.
CIEN is trading at more than $1.3 billion in market capitalization, adjusting for the debt of $1.4 billion and more than $540 million in cash, the enterprise value would be much bigger, settling at $2.2 billion for CIEN. Because of the thin equity carried in its book, the P/B is sky-high, at 95.2 times, and P/S is at 0.7x. With the acquisition of MEN in 2010, there would be expectation of CIEN to turn profits in 2012, but as noted above, the demand is there, but there are quite a lot of suppliers, so the competition for market share and to get worthy margin might be questionable.
With all the negative signals combined, the history of operating losses, negative operating cash flow, very large amount of debt backed by extremely thin equity, the concentration of customer base, and operating in the cyclical industry plus the fast changing in technology, especially with the constant selling out of its insiders, CIEN gives value investors every reason to say "no" to the stock. Soros’ buy might be well very speculative, as he has been involved with the stock over the years. With the equity fund value in management of $5.83 billion, the value of $70 million in CIEN stake represented only around 1.2% of the total equity fund value, not much of significant influence.
Unless any investors would like to play and speculate with CIEN with only a very small amount of their cash, then that should be fine. But it is definitely not the right type for investors to buy in for the long-run at the moment, and at this price, unless a year or two from now, the fundamental changes in both operating performance and the stronger financial structure.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk