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BT's 21CN Deals: Booty or Bloody?

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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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User Rank: Light Beer
12/5/2012 | 3:15:42 AM
re: BT's 21CN Deals: Booty or Bloody?
While there is no doubt the competition for the transmission domain portion of BT's 21CN buildout was intense, I think it is worth putting a few things in perspective here.

Current Exchange Factor
First, the 17%-18% depreciation of the dollar vs. the British Pound & Euro since the beginning of 2003 has made both US and Chinese products more competitive in overseas markets. So while we can be certain that Ciena and Huawei priced their equipment very aggressively to win the deal, they didn't necessarily have to price as aggressively as Marconi and other European vendors would have had to do in order to remain competitive.

This Deal Should Be Worth More Than Peanuts
Clearly, the cost of building a transmission network today is a small fraction of what networks cost only a few years ago. But this could be worth a fair amount of optical transmission business and potentially other future business for Ciena and Huawei. Take a look at Marconi's optical revenue numbers to get a perspective. Marconi generated 89 million Pounds ($US 171M) in optical equipment sales in its December 2004 quarter. If you consider the fact that BT represents about 26% of total revenue for Marconi and apply this ratio to optical, it looks like BT generated somewhere on the order of $45M in optical business in the Dec 04 quarter. The number could be slightly higher than that, given that Marconi said BT "increased its optical networks spend, with a view towards strengthening the transmission backbone to support the broadband access growth." In any case, it is probably safe to say BT spends $35M to $45M per quarter today on optical transmission equipment with Marconi. Going forward, BT is going to spend less per quarter overall, but what it does spend will shift in favor of Ciena and Huawei over time. And itGs not just Marconi that is losing out on transmission revenue here. The revenues of other vendors who have sold transmission equipment to BT also will taper off, and a modest percentage of that probably also will shift to Ciena and Huawei.

Transmission Domain Business Is More Than Longhaul DWDM
In the words of BT, GǣTransmission includesGǪthe electronics that converts the signals carried at high capacity over the cables connecting the MSANs, metro and core nodes. Much of the optical fibre infrastructure is already in place and today we are announcing the preferred suppliers for the optical electronics.Gǥ

While everyone points to the very low margins for LH DWDM, itGs useful to note that not all of the equipment involved is core DWDM. WeGre also talking about core optical switching -- which is more software intensive and traditionally has generated higher margins G and optical Ethernet equipment which is more directly linked to delivery of a very high growth service. BT is a big Ethernet service provider in Europe, and the importance of helping the operator deliver this service should not be lost in the noise here. OhGǪand I can bet you a box of Orville Redenbacher popcorn http://www.orville.com that the margins on the optical Ethernet boxes are better than for LH DWDM.

Other Implications
Various folks have noted some of these points, but it is worth recapping them: 1) this is a strategic blow to Marconi, which had been doing a good job of hanging in there after their recent restructuring; 2) raises questions about the combined technology / price competitiveness of other core optical players like NT and Lucent which historically have sold into BT; 3) helps reinforce the idea that Ciena is perhaps once again the premier provider of core optical systems G even though the company is more than an optical player today; and 4) makes it clear to the world that Huawei has the potential to be a serious contender in virtually any optical deal.
User Rank: Light Beer
12/5/2012 | 3:15:34 AM
re: BT's 21CN Deals: Booty or Bloody?
Dear Stan:
Great post, BUT it raised a question. How does Huawei come out of nowhere to be a credible optical transport vendor? They are not known for great innovation, as shown cleraly in the troubles COMS has had in selling their gear even to corporations, so their strength at BT begs the question of how complex their solution is. Is it just point-to-point stuff that has to be manually provisioned? Thats no deal for BT.
User Rank: Light Beer
12/5/2012 | 3:15:32 AM
re: BT's 21CN Deals: Booty or Bloody?

Good questions regarding Huawei. I would assume that BT will use Ciena to do the heavy lifting -- possibly making use of integrated optics on CoreDirector to lower combined transmission / switching costs -- and use Huawei where where capacity demand growth might be slower than other parts of the network.

One thing I find amazing is that Marconi actually announced a partnership agreement with Huawei earlier this year. Not sure how much, if any, that came into play in the BT account but it certainly didn't appear to help.

From Marconi's website:

Marconi and Huawei Partnership Agreement

London G January 31, 2005 G Marconi Corporation plc (London: MONI and NASDAQ: MRCIY) announces that it has reached an agreement with Huawei Technologies Co. Ltd. regarding ways in which the two companies will work together. Discussions between the two companies have focussed on a mutual distribution agreement that would see each company sell certain products from the other's product portfolio into their respective customers. The two Companies have also discussed how Marconi can use its extensive services structure to support Huawei's pursuit of equipment business in the European market.

A Memorandum of Understanding has been signed. Working groups have been formed by both companies, with a view to being in a position to sign a more definitive agreement before Marconi's financial year-end in March 2005.

Marconi will distribute certain of Huawei's carrier grade data products into its key customers. Huawei will distribute Marconi's next-generation access radio products into its key customers.
User Rank: Light Beer
12/5/2012 | 3:14:48 AM
re: BT's 21CN Deals: Booty or Bloody?
Huawei is not coming from nowhere in transmisstion,
they have more than a descent marketshare in China in that domain, and already couple of deployments in western countries...

Anyway, BT is not crazy, they'll only deploy products which succedded hundred of lab tests & validations..in case of one vendor not fullfulling BT requirements (overcommitment, roadmap delay, etc...), or one failing to deliver the equipment in the field, they can always fallback on something else.

The 21CN award was a framework agreement, with for sure very strict clauses on delivery capabilities. Non-incumbents vendors at BT like Huawei can by instance have clause like "deploy free of charge equipment of supplier X in case of non delivery of own equipment". Huawei is using a lot this "crazy" strategy in many western operators to de-risk them...
User Rank: Light Beer
12/5/2012 | 3:14:47 AM
re: BT's 21CN Deals: Booty or Bloody?
I am amazed by these negative statements about Huawei. I work for Huawei and can confirm that the quality and innovation of our solutions are on par and often exceeds the industry standard.

Huawei also does not come out of nowhere. This co has been in existense since 1988 and is a strategic optical network partner for many worldclass operators.
User Rank: Light Beer
12/5/2012 | 3:14:47 AM
re: BT's 21CN Deals: Booty or Bloody?
My sentiments entirely .....
BT did not go into this endevour with their eyes closed and are notoriously acute at crossing the 't's and dotting the 'i's in contract negotiations ...
Another point however:
I think we in the west do ourselves a great disservice to dismiss newcomers such as Huawei as '..not being innovative'. True they are playing catch-up to some extent - but boy how quickly they are catching up! I posed the question on another post some weeks back as I do not know the answer: how long did it take Cisco to win business from a Tier-1 carrier?
Interestingly, the comments regarding Huawei's innovation prowess (-or the lack thereof), tends to come from CEO's (read Bill Owens et al) who are already struggling against the threat of these new entrants .....
I think we would do well to learn something from car manufacturing, and the huge advances made by Asian companies over the past 3 decades .... A similar criticism was being thrown at Toyota and Honda in the 1980's when they proved they could beat NA counterparts at producing quality cars at affordable prices .....We were told then they would fall at the innovation hurdles .... Since then they have gone on to prove they can innovate, and infact the demise of Ford and GM is in part (yes there are other factors) due to the fact that they have been woefully inept at innovating ..... Toyota are on their way to overtaking GM as the largest car manufacturer in the world - in fact by some analysists reckoning they are already there ....
Two totally different industries I am aware, but I think there are some lessons to be learnt ....

User Rank: Light Beer
12/5/2012 | 3:14:47 AM
re: BT's 21CN Deals: Booty or Bloody?
and how many of these products were developed internally? I seem to remember several instances of dubiously acquired capability being reported over the last few years for several occidental companies.

Previous posters have it right - if it wasn't for massive government support they wouldn't be able to sustain the long term plan.

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