The last time I discussed Ciena, I questioned the company's competitive position against larger rivals like Cisco and Juniper , especially amid the weak carrier spending environment. In that article I said:
"If Ciena can show that it can innovate and leverage its existing technological advantage to fight off pricing pressure, then it certainly has a chance. Also, with so much R&D spending of late, the company needs to show investors the fruits of their support."
Since that article Ciena has done exactly what I've outlined and more. In response, the stock has soared close to 30%. With a rebound in spending from large carriers like Verizon and AT&T , I'm not ready to bet that Ciena's stock is done climbing.
I'm not suggesting that investors should dive in blindly. But after a solid second-quarter earnings report, I'm convinced that Ciena's worst is over.
Given Cisco's strong third-quarter performance and excellent guidance, there were plenty of reasons to be optimistic ahead of Ciena's results. With second-quarter revenue jumping up 6% year over year and beating expectations by 5%, the company didn't disappoint.
Ciena showed tremendous growth in packet networking, which was up a stunning 91% year over year. I've said on more than one occasion that the company's strength in networking along with its best of breed packet-optical business, which was up 10%, makes Ciena a prime acquisition candidate.
When Oracle put up $2.1 billion for Acme Packet earlier in the year, I sensed this was the first domino of a list of telecom companies that were going to get picked off.
The fact that Ciena has remained an independent for this long is surprising. But investors shouldn't discount this possibility, which makes the stock even more interesting, especially given the premium that Oracle was willing to shell out for Acme Packet.
As I noted recently, Alcatel-Lucent is aware of this potential domino effect and is therefore (in my humble opinion) fixing its books to appear more attractive. However, unlike Alcatel-Lucent, Ciena has not had issues with cash flow and is in much better shape to immediately produce a return to any suitor.
Along similar lines, I don't believe that Ciena's management has received the credit it rightfully deserves for having navigated this tough carrier spending environment as well as it has, especially since carriers account for more than 30% of the company's revenue.
Profitability has also begun to trend in the right direction, with gross margins advancing roughly 3% year over year. More impressive, however, was the 14% jump in operating income, which demolished Street estimates by 60%. What this tells me is that management has shifted its focus towards returning value to shareholders.
What's more, given that Ciena has secured product wins from the likes of Comcast and CenturyLink , the company is also gaining market share in some very important categories. It's evident that companies are looking for ways to differentiate themselves by delivering more value-added services to their clients.
This means that demand for network convergence with greater programmability will heighten. Very few companies have a portfolio that can offer these capabilities as well as Ciena's.
Investors should expect similar-to-better performance during the course of the next six to 12 months. Accordingly, from the standpoint of continued free cash flow and revenue growth, l see this stock as undervalued by at least 15%.
At the time of publication, the author held no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.