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Ciena, Infinera Top Optical Picks
The best sector investments may be in private firms but Ciena and Infinera look like the best public bets.
By MKM Partners
We recently attended and spoke at the GEN15 conference in Dallas organized by the Metro Ethernet Forum.
Our key takeaways from this important industry event are as follows.
With the unprecedented changes taking place in communications technology driven by software, the best investment opportunities are for private-company investors and corporate-development teams more than for public-company investors.
We can pick candidates for long-term leadership in vital new categories like Lifecycle Services Orchestration (LSO), Advanced Threat Prevention and software-defined networking (SDN) Controllers, but we can’t necessarily pick the winners yet.
Within the public-company domain, we view the Optical Systems companies Ciena (ticker: CIEN ) (rated at Buy, $29 price target) and Infinera ( INFN ) (rated at Buy, $27 price target) as the best places to invest.
More tactically speaking, we had the opportunity to speak live with Stu Elby, senior vice president of Cloud at Infinera, about the recent Data Center Interconnect (DCI) line-card announcement from Arista Networks ( ANET ) (rated at Buy, $81 price target). Elby thinks Arista will do well in the 20 kilometer (km) and below market, and notes that Infinera is much more focused on the significantly larger market for greater than 20 km distances.
Private-software companies steal the show. GEN15, the Metro Ethernet Forum’s (MEF) annual conference and trade show, has rapidly grown into an important industry event. This year, more than ever, private-software companies were well represented on the panels and in the exhibition hall. The industry mega-trends of SDN/network-function virtualization (NFV) are creating the opportunity for innovative software companies to become part of the next-generation OSS/BSS (Operational and Business Support Systems) in Telecom networks. According to industry analyst firms that track it, the global OSS/BSS market is healthy and growing with annual sales measured in the low tens of billions of dollars.
With all of the new technology, we sense some hesitation by Service Providers to make decisions too early. SDN/NFV is fundamentally about disaggregation, virtualization and automation. The disaggregation (of software from hardware and of specific functions from hardware) is creating the opportunity for a large number of new software companies to pursue potentially significant Service Provider sales. In our view, the new companies with the greatest chance to grow into large businesses are focused in the areas of LSO, Security and, to a lesser extent, SDN Control. However, it could take some time to occur since most Service Providers are still evaluating a lot of technology options, as well as the economic benefits versus trade-offs of various degrees of potential network disaggregation.
The most promising software companies are likely to be acquired by the established vendors. We think the new software companies that win the most significant Service Providers deals are more likely than not to be acquired by larger established Telecom Equipment companies. Examples of this have already happened in the LSO market, for example, with Cisco Systems ( CSCO ) (rated at Neutral, $29 fair-value estimate) purchasing Tail-f and Ciena buying Cyan. Two of the more-interesting private companies we spoke with at the conference are CENX, an emerging leader in LSO, and Cylance, an endpoint-focused threat prediction and prevention (Security) software vendor.
For public companies, we view the Optical Systems companies Ciena and Infinera as the best places to invest. Among the public companies we cover, Infinera and Ciena are our favorite stocks. Optical transport is the part of the network that is most difficult to virtualize, and is, therefore, much less threatened by Software. It is also where our Service Provider industry contacts most question the benefits of fully disaggregated Software control. This suggests Optical transport is less likely to become just a “dumb pipe” and is more likely to evolve to a layer of fully intelligent liquid bandwidth. In addition to these points, the number of serious competitors has shaken out as capacity and distance requirements scale. This has already happened in the longhaul and Metro markets due to 100G, and is likely to happen, in our view, in the DCI market as the industry moves to 400G and 1 terabit wavelengths in the coming years.
Comments on the Arista DCI line card announcement. Last week, Arista introduced a six-port 100G DWDM line card for its 7500E Spine switch targeted at the Data Center Interconnect market. The card has coherent DSP (digital signal processing) supplied by a third-party merchant vendor and claims transmission distances of up to 5,000 km. However, when we spoke with Elby of Infinera, he pointed out that Arista does not have a line system (i.e. amplifiers) and therefore, in practice, is limited to only very short distances (i.e. less than 20 km.) Further, the major Data Center builders are likely to deploy an integrated Switch + Optical solution only in very short reach on-campus building-to-building applications. Finally, Elby noted Infinera’s DCI business plan is much more focused on the more than 20 km market, and particularly 50-500 km, which is the large majority of the total opportunity.
Best,
–Kevin
