Alcatel: Survival Mode

| About: Nokia Corporation (NOK)

Alcatel-Lucent (ALU) is in survival mode.

When a company has taken the kind of beating Alcatel has over the past several years, it makes some investors want to throw in the towel. But the company just might have enough left to fight back against increasing competition and internal struggles.

Based in Paris, France, Alcatel-Lucent provides networking and communications technology, products and services. Its networks segment designs routers, multi-service wide-area-network switches, and content delivery network appliances. In addition, the company manufactures and markets microwave wireless transmission and optical networking equipment and wireless products for 2G, 3G, and 4G networks.

Alcatel stock has been very volatile in the last year. A year ago it was trading at nearly $2.50 a share. It bottomed out to $0.91 in October, climbed to $1.75 shortly after the new year and is currently trading around $1.32.

A Lightweight in its Industry

With a market capitalization of $3.4 billion, Alcatel-Lucent is a small fish in a very competitive pond. It's not out of the question that it could get swallowed - i.e. acquired - by one of those bigger fish. Rumors have surfaced that Nokia Siemens, one of Alcatel's fiercest rivals in Europe, may be interested in a deal.

In Asia, the company faces tough competition from Huawei Technologies and ZTE Corp. As a result of intense competition, revenues are falling, as are margins. Sales have fallen each of the last four years, from $21.72 billion in 2009 to $21.27 billion in 2010, to $19.87 billion in 2011 and $19.10 billion in 2012. The company's gross operating profit has declined during the same period, from $8.71 billion four years ago to just under $7 billion last year.

When it announced its earnings in early February, Alcatel reported a fourth-quarter loss of $0.80 a share, compared with a profit of $0.38 in the prior year's fourth quarter. Fourth quarter revenue was down about 1.3% year-over-year to $5.3 billion. For the full year, the company reported a much larger than expected loss of $0.81 a share on a 6% drop in revenue.

Alcatel has some serious debt, as evidenced by a debt-to-equity ratio of 2.47, meaning it has almost 2 1/2 times more debt on its balance sheet than equity. By comparison, one of its key competitors, Cisco Systems, has a ratio of 0.29. In December, Alcatel secured a $2.1 billion credit facility to help it refinance debt and cut costs.

A Match Not Made in Heaven

The company has been saddled with poor performance since it was formed by a merger of Alcatel SA and Lucent Technologies in 2006. Within two years of the merger, the combined company lost 62% of its market value, forcing the resignations of two executives who engineered the merger.

With its continuing struggles, it's not surprising that another change in leadership is coming. Outgoing CEO Ben Verwaayen will give way to new chief executive Michel Combes as of April 1. Combes is the former CEO of Vodaphone Europe and former chief financial officer of France Telecom.

The Good News

The news isn't all bad for Alcatel.

For starters, it should be noted that most of the annual and quarterly loss was due to a non-cash impairment charge; without it the company would have eared $48.42 million in the fourth quarter. Furthermore, the company generated $477.4 million in free cash flow in the fourth quarter. Although this was not enough to reverse the negative cash flow for the year, cost reductions helped lower the risk profile of the company. The company said it will reduce costs by an additional $961.6 million in 2013.

In July 2012, the company announced a major restructuring initiative, dubbed the Performance Program. The program, which was announced to run through 2013, is designed to cut costs by 1.25 billion Euros (about $1.6 billion in U.S. dollars), reduce the number of workers and exit unprofitable areas.

One area the company said it will not cut costs is in research and development, an area Alcatel has spent well over $3 billion annually for the last four years. The company is firm in its belief that it needs to continue those investments in order to compete in its core markets.

Under the new business structure, Alcatel is focusing on four core areas:

  • Wireless, where it will focus on its existing customer base in North America and China.
  • Core Networks, for both IP and optical networks.
  • Fixed Networks, where it will invest further and create synergies with small cell deployments.
  • Platforms, where the company will focus on using its network capabilities in unified software platforms for control, optimization and network analytics.

The company is also cleaning house of unprofitable contracts. According to the company, just 25% of its outsourcing contracts are profitable, which is a pressure on its margins. The company is planning to exit these contracts by the end of fiscal 2013.

Alcatel recently announced three key ventures. The company is working with China Mobile to rapidly deploy 4G-LTE in the world's largest mobile market. Alcatel has entered into an agreement with Telnor India to provide new networks to about 250 million customers. It also has an agreement with Regional Telecom to establish a 4G LTE network in the war-torn nation of Iraq.

Though the company has reduced its cash position each of the last four years, it still has $4.5 billion on hand. It has decent liquidity ratios as well, with a quick ratio of 1.0 and a current ratio of 1.3.

There are enough positive signs to convince analysts. Since the beginning of the year, the stock has received six analyst upgrades, including by Morgan Stanley and Goldman Sachs.

However, on the operational front, it is clear that it will take some time for the company to regain its position in the market and become profitable. Until, it will continue, under new leadership, new focus, and new cost-control measures, to survive an intense industry.

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

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.