Alcatel-Lucent's Challenge

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Alcatel-Lucent (ALU) shares have been on the rise on anticipation of the company's June 19 launch of its "Shift Plan," through which management hopes to restore the company to its former glory. The stock got as high as $2.01 on the day of the announcement, marking a 52-week high there. ALU has stalled since, and even closed down 7% on Monday on the China concern that affected the entire stock market. It was down another 2.2% Tuesday and closed down another 1.7% Wednesday. With the announcement now passed, investors will focus on the challenge at hand, which is substantial, and so the shares should see further downside near-term.

Chart forAlcatel-Lucent, S.A.

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In this first of a two part series, we examine Alcatel-Lucent's challenging reinvention strategy, entitled the "Shift Plan." We study the admirable targets and aspirations of the company's new management team. In the second part of the series, to be published shortly after, we will discuss red flags about the plan.

The Good in Reinvention

Reinvention is usually received positively by investors around ailing companies like Alcatel-Lucent, so I was not surprised to see the investor base rally around the news. Everyone wants to see the company turn a profit again and generate attractive returns to investors. So simply announcing an effort helps change sentiment about a stock, but without follow through, such enthusiasm will only last as long as the next poor quarterly report.

Alcatel-Lucent is looking to focus on high-value business, where strong growth and cash flow will result. It's the right idea for ALU shareholders, and value creation may indeed be in Alcatel-Lucent's future. The company will align itself with the priorities of its telecommunications customers and address their needs for next generation networks to satisfy bandwidth-hungry data traffic. Targeting the high growth areas of IP Networking and Ultra-Broadband Access should serve to siphon high-value growth from an increasing customer base, so also spreading risk.

I think it is value creating in its essence, but getting there may not be as smooth as shareholders hope. You can count on the fact that this author will be following closely, looking carefully for a true shift in operational momentum and shareholder value creation. If and when I see that, you can be sure that I will recommend the stock I today continue to be critical about.

The company has admirable goals that it says are also clear for managers to comprehend and act on. It also notes that the team is outfitted with the appropriate levers to deliver on its goals, intended to meet commitments to all stakeholders. The three-year plan running from 2012 to 2015 is targeting a 15% increase in Core Networking Segment revenues, to Euro 7 billion ($9.11 billion U.S.) in 2015, from Euro 6.1 billion in 2012. With that, the company says it should achieve a 12.5% operating margin in 2015, expanded from the 2.4% achieved in 2012. The company expects its Access and Other segment will achieve Euro 250 million ($325 billion U.S.) in operating cash flow in 2015, versus its Euro 115 million ($149.68 million U.S.) cash negative result in 2012. It certainly sounds good, but the challenge is getting there.

There's Always Fat to Cut

As companies grow, even for the better, they also tend to add a fat layer. It is a product of human nature I suppose, the result of operational complacency. It can often take a series of quarterly operating losses, the appearance of solvency concern, shareholder losses and sometimes management change to bring about serious effort for betterment. However, once engaged, cost cutting is always a part of corporate reinvention.

Cost cutting is also a part of Alcatel-Lucent's reinvention or "Shift Plan." The plan targets Euro 1 billion in cost savings through the adoption of direct channel operations and reduced SG&A spending for starters. Savings will also come from a change in R&D focus, with significant reduction in spending for legacy technologies and also more co-development work with major customers and partners. It is a bold target, and I have my doubts about whether it will be completed by 2015 as is planned, and if it is, if it will be an efficient and smoothly effected effort.

Knowing When to Call it Quits

The plan also involves asset sales to take the company away from poorly performing legacy operations. Some Euro 1 billion in asset sales is targeted through 2015. The company notes they will be carefully defined and timed divestitures, which reflects the concerns of shareholders, but also its important telecommunication customers like AT&T (NYSE:T) and Verizon (NYSE:VZ) and the markets where it operates. Indeed, the company offers an "editorial note" at the end of its press release stating that "a number of initiatives are subject to relevant information and consultation processes applicable in various geographies." The company speaks of real estate consolidation to drive efficiencies in project delivery, back-office IT systems, supply chain management and manufacturing and procurement. All these efforts are progressive, but also disruptive near-term.

From the open to its high point on the day of its announcement, ALU shares gained 6.3%, reflecting the revival of a beaten down shareholder base and the enthusiasm of new stakeholders. It might be telling to also examine the performance of the company's rivals on the day. June 19, was the day of the FOMC announcement, when the Fed stated formally it would begin tapering its asset purchases, so it was not a good day for stocks generally. Therefore, we cannot read anything into Cisco's (NASDAQ:CSCO) decline on the day. However, it appears clear that Ericsson (NASDAQ:ERIC) investors felt threatened by Alcatel's plan. That's a good sign.


June 19 Change

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Cisco Systems




Juniper Networks (NYSE:JNPR)


Despite the hope and enthusiasm about the plan, the company now has a significant challenge before it while burdened by a difficult operating environment. Things are only getting more difficult, with the cost of capital, something this company is very sensitive to, getting more expensive in the United States due to rising interest rates. This is a "sell on the news" story now, but it could later be a buy on the execution. For now, I would sell ALU, but I have my eye on the company's ambitious plan and will pay close attention to its execution of it for followers.

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.

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