Don't Bet On Alcatel-Lucent's Turnaround

| About: Nokia Corporation (NOK)

Telecom equipment maker, Alcatel-Lucent (ALU), announced its quarterly results last week. The results were no different from previous quarters in which the company reported losses as well. In the third quarter, the company generated revenue of 3.60 billion Euros ($4.62 billion), down approximately 3% from the third quarter of the previous year. Analysts were expecting the company to report revenue of 3.50 billion Euros ($4.50 billion). Despite the revenue beat, ALU posted a loss of 156 million Euros ($200 million) compared to a net profit of 220 million euros ($283 million) in Q3 2011.

Alcatel-Lucent, headquartered in Paris, has operations in over 130 countries and is involved in providing applications and services for mobiles, fixed, internet protocol and optic technologies. The company functions in the Americas, Asia Pacific, Europe, Middle East and Africa through two operating segments - Networks and Software and Services and Solutions - which are responsible for providing products and services to various telecom carriers.

Deteriorating financials and weak telecom spending:

The company's network division has been struggling in the recent quarters, and that has shown in its financials. In the third quarter, revenue from the network segment decreased by over 4% which would have been far more pronounced on a constant exchange rate basis (12%). The segment's operating loss was 149 million Euros ($191 million) compared to operating income of 70 million euros ($89.9 million) in the same period a year ago.

The major reason for this significant loss in revenue and profitability was the decrease in spending by various telecom operators on their mobile networks. As telecom carriers are spending more on their 4G network roll outs, revenue from its wireless division can be expected to go down further due to weakness in 2G and 3G technologies. The company's optic business, which is responsible for designing data transportation equipment through land and sea, suffered a 17.5% decline in revenue in the third quarter due to weakness in its submarine optic business.

Serious liquidity concerns:

The company is burning cash on a regular basis. In the first half of the year 2012, ALU burnt over 600 million Euros in cash, which is probably the reason why the company's management is seriously considering a possible asset sale and debt refinancing. ALU's debt is currently rated junk by Moody's. The company needs to improve its liquidity position because it will continue to face financial worries in the absence of positive cash flows. Currently, ALU has more debt than cash on its balance sheet and even its recently announced performance program, which involves the laying off of thousands of workers, has not been able to stem its losses.

CAPEX hike by AT&T (NYSE:T) offset by weak European spending:

The second largest telecom operator in the U.S., AT&T, recently announced in a press release that it will boost its capital spending to $22 billion per year for the next three years on wireline and wireless infrastructure buildup. This boost in spending is a 16% growth from the previously announced $19 billion. Even though companies like Alcatel-Lucent would benefit from this hike in spending from AT&T, as the latter accounts for almost 10% of ALU's total revenues. We expect the weakness in spending to continue in the debt-stricken Eurozone which provides an even larger chunk of its revenue base. So the two regions will largely offset each other, resulting in an insignificant change in the company's gross or operating margins.

Margins under pressure:

With the top line continuously under pressure, it is no surprise that the company's gross and operating margins have not expanded. ALU posted operating margins of 0.76% in FY 2011 compared to Cisco Systems, Inc.'s (NASDAQ:CSCO) margins of 22%, which have followed a consistent upward trend. Prior to 2011, ALU has been posting operating losses.

ALU has lost almost a third of its value since the start of the year. However, the worst decline came just after the company reported its results for the third quarter, losing almost 10%. ALU is trading at 13 times its trailing earnings, a premium of over 200% to its historic average. Forward price to earnings multiple of 20x for ALU is also much higher than Ericsson's (NASDAQ:ERIC) multiple of 13x, indicating that the stock is expensive on valuations. Since our last report, the stock is down 12%, and we reiterate our previous sell stance based on continued operational deterioration for the company and expensive valuations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Telecom Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.