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Ciena Sees Red at BT

Two things happened today. Ciena (CIEN) inked their contract with British Telecom for the BT’s 21CN project. And Marconi shareholders approved the sale of the company to Ericsson. Many readers know these two minor events have a bellwether common denominator – a willingness to meet the new price targets set by Chinese competition.

Just as Vietnam and Afghanistan were proxy wars for the 20th century superpowers, BT’s 21CN will be the first full-blown encounter between incumbent and Chinese research, customer service, accounting practices, and cost structures.

BT (BT) is spending 10BB British Pounds to rewire the core of their network, in essence a full forklift upgrade of Britain’s transport infrastructure. It’s a big project and has been well covered in the press, particularly by Lightreading. The technology is ultra sexy (WDM, Digital Wrapper, MPLS, GFP, the list goes on and on), and while I like cool telecom technology the business match up and the way the outcome will resonate into markets is far more interesting.

We are deeply interested in the impact Chinese hardware will have on the global telecom equipment market. Huawei and ZTE make noise about their big push into overseas markets but the reality is they have yet to ship big volume into the infrastructure of any Tier One telco outside of China. The first real debutante ball for Huawei (and a proxy for ZTE) in a foreign market is 21CN.

Huawei was selected along with Ciena to supply the WDM transport equipment. Huawei was also selected alongside Fujitsu in order to supply access equipment. It’s the first time we’re going to see a match up between the high cost western suppliers and the low cost suppliers from China. The first big shock in this deal came when BT decided against using – Marconi, their incumbent supplier. Marconi went on the record as saying they simply could not hit the price targets BT wanted. They probably figured BT would pay more to use a trusted supplier and negotiated to that end. Oops.

“This is a disappointing outcome from a very competitive tender process,” said Marconi CEO Mike Parton in a statement. “Our products performed extremely well technically, but we have been unable to meet BT’s commercial requirements.”

A few months later, after two years of navigating a bankruptcy, Marconi is absorbed into Ericsson and becomes the first casualty of the new Telecom war.

Now, the ink is drying on the contracts for 21CN. Ciena is supplying the CN4200, a mash up product from one of their better acquisitions, Internet Photonics, and the WDM transport expertise Ciena built their reputation on. Products like this are defining the new future of the Ciena after the acquisition and subsequent detonation of many companies and products, particularly Coredirector. A number of expats from the Coredirector team now run Infinera, which is building a similar product to the 4200. This product area is a core competency for Ciena and was crucial for strategic validation and internal morale. They scored the deal and are now in the game.

Huawei is competing in an area that plays to their strengths. Transport equipment is the least software intensive part of the equation, so a lack of system integration experience with big Telco software isn’t a big disadvantage. The hardware engineers I’ve worked with at Huawei are technically on par with the west, except they work much harder for less cash. There is a strong nationalistic hunger within Huawei and ZTE; they don’t just want to beat the western companies financially they want to exhibit the technological strengths of their country.

The BT 21CN rollout is going to offer us a front row seat into what the future of Nortel (NT), Lucent(LU), Alcatel (ALA), Siemens (NOK), Marconi, Fujitsu (FJTSF.PK), NEC (NIPNY) and others is going to look like. What exactly is the financial impact of competing with Huawei and ZTE?

Ciena will be the best proxy yet. Whatever pricing they gave BT to win this deal has already been shared over beers with every other tier 1 carrier, and the margins in the transport business are likely to fundamentally change. 60% of Ciena’s business is expected to come from transport, any damage (or lack of it) will be readily apparent and not buried within the P&L of a behemoth like Lucent or Nortel, at least for some time.

Ciena has shown solid financial improvement over the last three quarters. They appear ready for the fight but there are two things we’re particularly interested in:

  1. Gross margins on the incremental business from the BT contract
  2. Share of the business Ciena wins from Huawei.

This data will be the closest thing to a crystal ball when it comes to forecasting the financial future of optical networking.

[Update 5 Feb 2006] This post was linked from a George Gilder Tech Forum. I am not a member but would appreciate someone sharing with me the context in which I was quoted.