http://www.barrons.com/articles/be-cautious-on-cisco-juniper…
MKM Partners
Here in early 2016 we see three Telecom Equipment industry trends worth discussing.
These are: 1) The backdrop for U.S. wireline-access demand is surprisingly strong; 2) the 100G optical supply chain has been heating up; and 3) we remain cautious on data networking companies like Cisco Systems (ticker: CSCO ) (rated at Neutral, $29 fair-value estimate) and Juniper Networks ( JNPR ) (rated at Neutral, $31 fair-value estimate) in 2016 as software-defined networking (SDN) and network functions virtualization (NFV) have another year to mature and to begin to make an impact on the $6 billion-plus edge router market.
For Juniper, specifically, we are not worried about fourth-/first-quarter estimates, but we think the risks increase later in the year. For Cisco, we see downside to consensus revenue estimates as soon as fiscal third quarter (ending April), which is the quarter management will be giving guidance for on the next earnings report in February.
There has not been a positive secular industry theme for wireline access for several years. Accordingly, the stocks in the space have not performed well with Adtran ( ADTN ) (rated at Buy, $21 price target) down 22% and Calix ( CALX ) (not rated) down 19% over the past year versus the Nasdaq Composite flat. Going forward, however, Connect America Fund Phase 2 (CAF2) is likely to underpin the U.S. wireline broadband access market with much more certainty, predictability and, most important, with a significantly greater number of sizable FTTC (Fiber-to-the-curb)/xDSL upgrade projects.
In September, 10 carriers accepted a combined $1.5 billion under CAF2 to build out broadband access in underserved regions. The same carriers are slated to receive similar installments for the next five years, making the total planned CAF2 distributions greater than $9 billion over six years. Adtran has existing customer relationships with seven of the 10 CAF2 Carriers, and is actively engaged in CAF2-related projects and/or requests for proposals (RFPs) with all 10, according to our checks. We think the CAF2 equipment opportunity for the industry in 2016 is about $500 million, of which about $300 million is the type of access equipment Adtran and Calix sells.
We upgraded Adtran to Buy last week. We expect Adtran to perform significantly better in 2016 than it did in 2015. Last year, revenue declined about 5% due to a lack of significant new carrier projects, enterprise channel and inventory execution problems and the weaker euro. We think the situation will improve meaningfully in 2016 as the number and scale of new carrier projects significantly accelerates and Enterprise execution improves. The major new service provider opportunities for 2016 include projects with the 10 CAF2 carriers, vectoring at CenturyLink ( CTL ) and second-source FTTC at AT&T ( T).
We are upbeat on optical systems stocks Ciena ( CIEN ) (rated at Buy, $26 price target) and Infinera ( INFN ) (rated at Buy, $24 price target) as 100G longhaul demand remains solid and Metro 100G is set to positively inflect in 2016. In addition, we have recently become more positive on stocks in the 100G Optical supply chain such as Lumentum Holdings ( LITE ) (rated at Buy, $26 price target).
We estimate Verizon Communications ( VZ ) will spend approximately $100 million in calendar 2016 on Metro 100G Optical systems from Ciena and Cisco Systems (rated at Neutral, $29 fair-value estimate). In addition, we expect AT&T to spend about $75 million on 100G Metro systems from Ciena in calendar 2016. Lumentum is the Reconfigurable Optical Add-Drop Multiplexer (ROADM) supplier for these deployments, which appear to provide the company with solid visibility to sequential ROADM revenue growth throughout fiscal 2016.
Our optical-supply-chain checks have considerably strengthened over the past month as a positive wave of Chinese 100G transport demand has washed over the industry. This better Chinese demand is apparent in our recent conversations with companies that make transmission components and modules, and with optical contract manufacturers. Other companies we believe are benefiting from the better industry conditions include Finisar ( FNSR ) (rated at Neutral, $13.75 fair-value estimate), Oclaro ( OCLR ) (not rated), NeoPhotonics ( NPTN ) (not rated) and Fabrinet ( FN ) (not rated).
Best,
–Kevin
