Since reporting first quarter earnings, Alcatel-Lucent (ALU) is up 45%, when shares bottoming at $1.30 in 2013. The transition story for the company continues to unfold successfully. The company has a 3 point plan to improve its performance. A core part of its strategy is that the company is growing sales in new products to offset its eroding sales from legacy businesses. With shares approaching U.S. $2, there could be more upside. More importantly, there are a number of reasons Alcatel-Lucent could trade beyond $2.
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1) Clear Business Strategy
Alcatel-Lucent outlined its strategy for improving the company's performance during its first quarter conference call. They were:
1. Have a revenue mix that supports higher gross margins
2. Reduce expenses by $1.25 billion
3. Stabilize balance sheet
The strategy is clear and concise, and the company is progressively achieving each of them one quarter at a time.
2) Cost Reduction
Alcatel-Lucent reduced costs by EUR 100 million in the last quarter. Head count dropped by 5,400, with 3,200 coming from renegotiating contracts for managed services. The net result was a 5.5% decline in operating expenses for the first quarter. Efforts to decrease managed service sales are continuing. The company expects revenue from this segment to decline by EUR $400 million.
3) New Product Launches
Alcatel-Lucent launched new software defined network (or SDN) products and a new core router last quarter. The company gained eight customers in the first quarter. The router segment is in competition with routers offered by Juniper (NYSE:JNPR), but Alcatel-Lucent is confident that it will grow sales. The company touts a low total cost of ownership for its routers, a four-fold advantage in speed, and 50% of the floor space as reasons to choose Alcatel-Lucent routers.
4) Strong LTE Revenue
LTE revenue was at the highest level ever. Demand for LTE is expected to remain strong in North America. In China, TD-LTE remains in mobile trials, and Alcatel-Lucent hopes growth will take place in the second half of this year.
5) Lower Legacy Product Sales
The company reduced sales of legacy products by 50% compared to the previous year, in favor of higher margin products. The shift towards LTE sales is continuing. Alcatel-Lucent's Wireless division grew 6% in sales (year over year), while legacy product lines for fixed networks declined 47% in the same period.
In the optics segment, the WDM (wavelength-division multiplexing) business is growing, thanks to the 1830 platform accounting for 36% of total hardware sales in optics. This will replace the decline in Legacy sales.
Cash flow declined in Q1 to negative EUR 530 million. Last year, cash flow was helped by growth in receivables. The reasons for the negative cash flow were the impact of improving inventory levels and gross margins in the first quarter, which was 29.4%.
Alcatel-Lucent forecasts an improvement in cash flow over the next three quarters. This will be driven by contract wins and activities associated around the submarine segment.
Alcatel-Lucent has a healthy backlog of EUR 8.9 billion. Its customer base is broad, with Verizon (NYSE:VZ), Sprint (NYSE:S) and AT&T (NYSE:T) contributed to more than 10% of total revenue. Continued refinancing activities, like its recent US$763.8 million, will lessen investor fear that the company will be operating towards bankruptcy. The company has a heavy $8.8 billion debt load, but the company is on-track to turnaround its businesses. As this transition continues, the debt burden will shrink. More importantly, investors will be rewarded through a higher share price in the quarters ahead.
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.