Ciena (CIEN) shares have been on a bit of a tear recently, rising 20% in June. Unfortunately we haven’t participated in this gain and I believe it is worth explaining the historical thinking behind this decision.
In the past, optical transport has been hardware intensive and light on software content. The big volume metro boxes of the bubble such at the Nortel 5200 and the long reach systems in particular didn’t have differentiating software. The R&D was in the optics. It is for this reason I viewed this sector as ripe for commoditization, particularly by vendors such as Huawei (see “Ciena Sees Red at BT“). It is for this reason we avoided Ciena as an investment. This is now a flawed assumption.
The future of the core network increasingly appears to be Layer 2 based- whether it is Ethernet, T-MPLS, PBT is a secondary issue. Implementation of these new Metro Ethernet protocols is about as far away from a commodity as you can get. Systems vendors, such as Ciena, are producing systems that merge Layer 2 Ethernet switching with traditional optical transport functionality. In the past carriers would avoid such ‘god boxes’ for a number of reasons both good and bad, preferring to keep the switching and transport elements separate.
The Chinese wall between these functions now appears to be breaking down. The fact is that without some compression of transport and switching equipment carriers will not drive their operational expenditures down. This is a primary concern that trumps the political, technical, and historical reasons that they were separate. The inclusion of Layer 2 functionality is deflecting transport equipment from a commodity future, at least temporarily. This is a major shift and is forcing a change to a core investment thesis.
The Ciena 4200 series attracts the most investor attention but it is a glorified transport multiplexer with limited L2 intelligence. It filled a market need but it not at the vanguard of innovation. The new Ciena 5060 platform evolved from their Wavesmith product, which bridged legacy ATM networks and allowed carriers to cap ATM switch expenditures. This new system converts a fistful of protocols into Ethernet and is a better example of a Ciena Layer-2 Ethernet product. If Ciena is successful in the carrier Ethernet market, it will be because of the 5060, not the 4200.
It is surprising to me that Cisco (CSCO) and Juniper (JNPR) are still so notably absent from this market. Both have the deep Layer 2 (and Layer 3, and Layer 4…) expertise to be a force in the Carrier Ethernet market, particularly with the strength of their network OS. The common refrain is that their Enterprise networking roots make them unsuitable for carrier consumption but the recent success of the GSR12k refutes this. How long will it be until Cisco repositions itself in the metro market with a junior version of the GSR12k?
There are other systems such as the Fujitsu Flashwave 9500 and Nortel (NT) OME 6500. These are heavy iron telecom systems with myriad functionality. As an engineer at a major dark fiber carrier explained to me “they do everything but do nothing well.” These vendors are developing systems with one foot in legacy TDM and another in Layer 2.
There are four Metro Ethernet scenarios that we see developing.
All of these scenarios will see deployment but it is too early to tell which will dominate. In theory, the new business plan of Soapstone (aka Avici (AVCI) ) makes sense since a platform agnostic software layer would allow carriers to mix and match platforms and avoid being held hostage to one equipment vendors native operating system. (see “The End of Telecom As We Know It And I Feel Fine“
Ciena has masterfully played the Ethernet PR card but the race for market share is only beginning. Ciena, at it’s core, is still a Layer 1 transport company, and is positioning itself as a Layer 2 Carrier Ethernet company. If successful, this would remove the threat of commoditization and is deserving of closer study.
Note I still haven’t changed my mind on NPU’s…