Alcatel-Lucent: Why It's A Smart Investment

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For most investors, Alcatel-Lucent (NYSE: ALU) seems like a lost cause. With stock prices trading at a 52-week range of $0.91 to $1.79 and a first quarter net loss of $460 million (353 million euros), not to mention a cripplingly heavy debt burden, the possibility that the company may go bankrupt has even been raised. But many analysts believe Alcatel-Lucent may yet manage a turnaround, in which case investors holding on to its stock may suddenly find themselves richly rewarded.

Alcatel-Lucent's Downfall

Ever since the French firm Alcatel and US Lucent Technology merged in 2006 in the hope of creating a company that could stand up to intense competition in the telecom field, Alcatel-Lucent has been struggling, to the point where many analysts have started declaring the merger a failure. While the company managed to report revenues of $4.2 billion (3.23 billion euros), it had a free cash flow loss of 533 million euros. In fact, it has been burning through cash at a fierce rate since the merger, at an average rate of 700 million euros annually.

So what happened to this once-promising company? Basically, it failed to maintain its competitiveness against rivals such as Ericsson (NASDAQ:ERIC), Cisco (NASDAQ:CSCO) and the Chinese telecom firm Huawei, which were able to be more cost-efficient. As a result, the company suffered from weak revenue growth and even recorded negative growth in 2011 and 2012. It also lost several major contracts.

However, its weak performance hides the fact that the company actually still has a lot going for it. For example, it remains one of the world leaders in fixed line communication technology, particularly in VDSL2 vectoring technology, a DSL technology that allows providers to give their subscribers super-fast broadband connections with downstream speeds up to 100 Mbps over existing copper access infrastructure. Lost amid the news of its disappointing Q1 2013 earnings was the fact that it shipped its one-millionth VDSL2 vectoring line. In addition, its world-class portfolio of communications technology patents have led it to be recognized in 2012 as one of the Top 100 Global Innovators and a Technology Supersector Leader. Hence, the problem that Alcatel faces is how to turn its innovations into profits for the company.

A Change in Leadership

Alcatel-Lucent is currently pinning its hopes for a turnaround on its new CEO, Michel Combes, who is replacing the outgoing Ben Verwaayen, who was forced out due to the company's continuing losses under his watch as well as his failure to develop a profitable strategy for the company. Combes is a veteran of the telecommunications industry who has successfully implemented cost-cutting measures at Vodafone (NASDAQ:VOD) as well as France Telecom SA (OTCPK:FNCTF).

In line with this mandate, Combes initially put into place a restructuring plan that would cut expenses by more than 1.25 billion euros a year and eliminate some five thousand jobs. However, he still plans to unveil an upgraded restructuring strategy, the details of which will be revealed later in the year.

One immediate problem that Combes will have to face is how to deal with the company's heavy debts. Alcatel has total liabilities of $24.6 billion, of which $3 billion is scheduled for repayment in three years. One possibility that the company has considered is to leverage its patents portfolio to raise at least a billion dollars in new funding. Alternately, it may put up its routing business as collateral for the new credit.

In order to avoid the possibility of its patent portfolio being lost, the government of France is considering taking out a minority stake in the company. In addition, Alcatel-Lucent is also considering a merger with Nokia-Siemens, although analysts have questioned if the move would actually be beneficial for the companies considering they are both still struggling with their own respective mergers.

One factor in Alcatel-Lucent's favor is its strong presence in the US market. The company currently has 42% of the North American market for the point-to-point microwave transmission equipment that is a major requirement for backhauling the network traffic load of 4G LTE networks. Growth in American markets has helped make Alcatel-Lucent's IP unit one of its most profitable, with revenues of $642 million (493 million euros) for the first quarter of 2013.

The Bottom Line

The difficulty with making a recommendation as to whether investors should buy into Alcatel-Lucent lies in the fact that the future of the company remains uncertain. So much has gone wrong for Alcatel-Lucent that it would be extremely difficult for it to regain even a fraction of the status its component companies once had. Cost cutting would definitely have a positive impact on the company's bottom line in the short-term, but this would be sustainable only if the company is able to come up with a viable growth strategy. If it can, the rewards for investors would be great as share prices could theoretically double in value. Hence, investors with a high tolerance for risk should consider adding ALU stock to their portfolio.

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