Four months ago I wrote an article entitled "Is There Another Sprint in the Market", which included four companies that I believed could become the next Sprint Nextel (NYSE:S). This came in response to my continuous coverage of Sprint during the last year, as the stock presented the most evident upside at $2.30, and has since rallied 140%. Despite the fact that others on the list, Level 3 (NYSE:LVLT), Netflix (NASDAQ:NFLX), and Nokia (NYSE:NOK) have rallied, I still believe that Alcatel-Lucent (ALU) is presenting the most clear Sprint like upside in the entire market. Furthermore, after more than a year of being bullish on Sprint, it might now be time to change the outlook.
What Made Sprint Special?
In case you never heard my case for Sprint, back in the beginning of the year, it was really quite simple. My reason for Sprint being my top value of 2012 was because of three factors: The iPhone, a 50% loss of value, and an edge over its competitors with unlimited data. These factors came together in 2012 to create the perfect stock.
Sprint's fundamental weakness in the year's prior to 2012 was a result of it not being able to compete with its competitors due to it not having the product that consumers wanted, the iPhone. To make matters worse, Sprint worked hard to try and match the presence of AT&T and Verizon in terms of locations. These factors plagued its fundamentals, but in 2012 allowed it to thrive.
When Sprint was given the right to sell the iPhone it already had the presence and it had an edge with its unlimited data and the lowest depository in the industry. Sprint had continued to lose market share in the past, but common sense suggested that with its presence, unlimited data, low deposits, and of course the iPhone, that its sales and retention rates would rise. Finally, the last piece of the puzzle that made it all come together was that Sprint was trading with a 50% loss from its 2011 highs despite having the iPhone! The stock had been trading over $5.00 with the problems of losing customers and revenue but then due to the selloff in 2011 its stock fell below $2.50. As a result, Sprint thrived, and was therefore my clear cut pick for the best value of 2012.
Alcatel-Lucent is Sprint
Looking ahead into 2013, I believe that Alcatel-Lucent is presenting even more value and potential upside than Sprint. Much like Sprint, a large majority of Alcatel-Lucent's loss over the last two years has been a result of market conditions, seeing as how Alcatel is a European based company. However, Alcatel-Lucent is a massive company, with over $18.5 billion in revenue and valued at just $2.5 billion. And much like Sprint, Alcatel-Lucent has the iPhone like catalysts in the next year to push its stock significantly higher.
Looking ahead to 2013, Alcatel-Lucent has three major catalysts: The increased spending on behalf of AT&T (NYSE:T), outcome of Goldman Sachs negotiations, and finally Light Radio. In November, Alcatel-Lucent traded higher after AT&T announced plans to increase spending to $22 billion on capex for each of the next three years. Alcatel-Lucent is AT&T's largest equipment provider and looks to benefit from this spending more so than any other company. This service includes a profitable and fast-growing segment of Alcatel-Lucent's business, and it will look to continue growing this segment with new partnerships in fast-growing economies such as in China. However, the massive equipment maker will also be looking to downsize and cut some of its unprofitable businesses, which will also be a huge catalyst.
Due to Alcatel's $2.5 billion market cap a lot of people don't realize the pure size of this company. It stretches into more than 130 countries and has nearly 30,000 patents to create $18.77 billion in revenue. However, back in November the company announced that it was in talks with Goldman Sachs for the purpose of raising money by selling certain assets, including the monetization of patents. The good news is that Alcatel offers services that its clients in emerging markets cannot lose. Therefore, the company has leverage going into negotiations, and should be able to sell its unprofitable businesses to the companies that utilize the services.
The problem with Sprint back in 2011 was that its business was too large for the amount of revenue it created. The company had massive operating costs and needed top-line growth, which is why the iPhone was so important. However, Alcatel does not need revenue, it needs profits. The company's plan involves eliminating a significant amount of its revenue, but also eliminating the businesses that return loss. Right now, the company has an operating margin of just 0.49%, which is far below industry competitors Cisco with 22.79%, Ericsson with 7.20%, and Juniper's 9.51%.
In the telecom equipment industry margins are everything, and are weighed heavily by investors. Consider the fact that Alcatel has the lowest margins and trades with a price/sales of just 0.13. In terms of operational size it is one-third the size of Cisco, but Cisco trades with a market cap that is 41 times greater. Alcatel is four times the size of Juniper (operational size) but Juniper is worth four times more than Alcatel. This proves that investors care more about margins, and with the company's new strategy of downsizing to become more efficient, it should be rewarded by Wall Street with a similar valuation as its competitors.
If Alcatel-Lucent loses 10% of its revenue yet can achieve margins of just 3% it would return a profit of more than $500 million, rather than its current 12 month loss of nearly $200 million. The benefit to the company's current operational strategy is what investors have been seeking for the last two years. The company will see growth from the segments that matter, from capex spending in the U.S., network upgrades and development in China and Europe, and the company's solution to the Broadband radio spectrum demand with its "Light Radio".
The demand for radio spectrum is one of the fastest growing industries/problems in the U.S., as consumers continue to download videos onto smartphones and tablets. It is estimated that in the next few years the problem could become up to 25x greater, creating a capacity problem that is 100 fold. Alcatel's Light Radio is a cube that uses the cell phone signals of a carrier's network to provide service, therefore freeing up broadband. In my opinion, the transformation of the company's operational strategy is the needed catalyst but Light Radio's ability to monetize the delivery of video from the cloud and from content delivery networks should become a hot ticket among service providers. It is an innovating technology that will take some of the spectrum demand and could also create new opportunity.
Re-Diversifying Your Portfolio
The end of every year is my favorite time of the year for investments. I trade, buy, and sell throughout the year but for the most part I leave the bulk of my portfolio alone. But at the end of every year I re-diversify my portfolio. I take a look back at both fundamental and technical performance, and then I make a decision based on those two factors.
Ever since I purchased 10,000 shares of Sprint at $2.36 at the end of November 2011 I have remained bullish and have maintained my outlook. However, last week I took profits, selling my position at $5.70. The reason I sold is because a lot has changed with Sprint, and the needed catalysts to take it higher are different.
Sprint has been driven higher because of increased subscribers and top-line growth. But now, with a $17 billion valuation, the company needs more. It needs profit, and it needs continued growth. However, with the launch of the iPhone 5 we saw a slew of new carriers obtain rights to sell the phone. Therefore, this could create a problem for Sprint, and for the first time in over a year, I don't see the clear and distinct value, and I believe success is priced into its stock.
Over the last two years I have owned shares of Alcatel-Lucent at some point in time. But I have kept my position fairly small. But recently I increased the size of the position due to my belief that the catalysts and value being presented are enough for the stock to see Sprint like gains in 2013. I'm not saying that it won't trade flat for the next three months, nor am I suggesting that it will not fall below $1.10, although I believe the downside is limited. If you look at Sprint it fell another $0.26 from my purchase price and remained dead money in my portfolio for nearly six months. However, I knew that because of the catalysts and the value that eventually it would trade higher, but that patience was required, and in regards to Alcatel-Lucent, I see the same scenario.
Disclosure: I am long ALU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.