May 10, 2005
As further details come forth about the booty in the long-haul portions of BT Group plc's (NYSE: BT; London: BTA) 21CN contract awards, experts are starting to wonder if the low-margin transmission business is worth it at all. (See BT Unveils 21CN Suppliers, Ericsson to Bring Partners to 21CN Party, BT's 21CN: Metro Partners Under Wraps , and Fujitsu Shares Its 21CN Success.)
The core transmission portion of the contracts will generate some business for the likes of Huawei Technologies Co. Ltd. and Ciena Corp. (Nasdaq: CIEN). But everybody seems to be acknowledging that the price competition in the bidding was brutal, resulting in some low-margin business.
"We believe the margins to be razor thin, especially considering the inclusion of Huawei in the deal," writes analyst Alex Henderson at Citigroup of Ciena's contract win.
Long Haul, Low Margin
It's now clear that Huawei and Ciena have made the grade in BT's core network (see BT Picks Ciena for 21CN and Huawei Picked for BT's 21CN). Dig a little deeper, however, and the picture isn't as pretty.
The Chinese vendor is keeping its lips sealed, due to "internal issues." But Ciena is prepared to talk.
The vendor's VP of international sales, Francois Locoh-Donou, confirms Ciena will supply three products to BT for the 21CN: its CoreDirector optical switch, which BT has been sourcing since 2003 (see Ciena's BT Coup: How Big?); its CoreStream long-haul transport platform; and its CN optical Ethernet service delivery platform, which is suited for aggregating enterprise data traffic.
He adds that Ciena is going solo and won't be bringing any partners along for the ride.
So what's this deal worth to Ciena? Not surprisingly, Locoh-Donou can't say any more than "it's a large contract of significant value," adding that "BT hasn't finalized its plans, so even it doesn't know."
It does mean that Ciena will be hiring new staff in the U.K. to support BT, but the Ciena man is also loathe to put a figure on those plans.
What's clear, though, is that the deal isn't likely to bump up Ciena's gross margins, currently in the mid-20s, during the next few years (see Ciena Shows More Revenue, More Loss).
"The 21CN deal was very competitive, perhaps more so than others," says Locoh-Donou. "Margins are under pressure in every carrier deal out there today. There's oversupply in this industry: There are too many vendors, so there's a lot of price pressure."
Is that price pressure being made worse by Huawei, which is notorious for undercutting rivals with rock bottom prices? Locoh-Donou says it's not that simple. Price competition for the BT deal was intense, "but whether that's just because of Huawei's involvement, I don't know. Huawei isn't the only one that's aggressive on price. There are European vendors that are even more aggressive on pricing," he adds, without naming names.
Citigroup's Henderson reckons the margins are a "negative for Ciena," and he doesn't believe the 21CN gig is even that big of a deal.
"We believe the transmission category represents far and away the smallest revenue opportunity of the five segments, as BT could likely build an entirely new, high capacity optical network in the UK for well under $100 million," writes the analyst in a research note. "With this new project its level of revenues from BT could grow by as much as much as $50 million in total over the next several years."
Henderson concludes that the 21CN deal, with its low margins, "is not in the best interests of a company like Ciena that has major profitability and cash burn issues to contend with."
Such analysis raises the whole "Is it better to be in at any cost?" debate that has raged since Marconi Corp. plc (Nasdaq: MRCIY; London: MONI) decided not to go as low as BT wanted on price and ended up with nothing. The result? Stock freefall and major job losses (see Marconi in Turmoil and Marconi to Cut 800 Jobs).
Core Blimey! Lucent Pitches In
BT's choice for its IP core routing gear didn't raise any eyebrows, though it's notable that Cisco Systems Inc. (Nasdaq: CSCO) was engaged directly, while Juniper Networks Inc. (Nasdaq: JNPR) has found its way in via partner Lucent Technologies Inc. (NYSE: LU) in the core category, and probably via Siemens Communications Group in the metro category.
As mentioned previously, Cisco, which is also a 21CN metro node supplier, is delivering its new core router, the CRS-1 (see BT's 21CN: Metro Partners Under Wraps ).
As for Lucent, well, it's more than chuffed with its inclusion as a partner with Juniper (see Lucent, Juniper to Supply BT 21CN). It will supply Juniper's TX, T640, and M320 routers, and its core IP network element management system (see Juniper Unveils the TX, Juniper Goes Terabit With the T640, and Juniper Hatches the M320)Lucent's U.K. managing director, Andrew Taylor, says its software has been developed jointly with Juniper to provide a single view of its partner's infrastructure elements. "We're not just a channel for Juniper's products. We're developing technology with them, too," says Taylor. "That was a major factor in BT's decision."
Lucent's main role, though, is as a supplier of network support and services. "We already have 1,000 people in the U.K., and already manage four or five of BT's legacy platforms, but that's a different challenge altogether. "BT's main challenge now is how to integrate the new systems and then migrate from the existing network to the new. That puts the onus on the vendors to work closely together. We're going to be involved in deploying, testing, and maintaining the new network, and we'll be building up our expertise here in the U.K. over the next few years and creating a center of excellence."
Providing those sorts of services could be good business for Lucent, reckons Merrill Lynch & Co. Inc. analyst Tal Liani. "Lucent could actually be a surprise winner here as its services business carries relatively healthy direct operating margins," while it's simply a reseller of the hardware, and therefore not affected by its "aggressive product pricing," writes the analyst in a research note.
— Ray Le Maistre, International News Editor, Light Reading
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