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Alcatel-Lucent (NYSE:ALU) is making solid moves and the stock is up considerably in the past few months. Overall, the networking equipment manufacturing industry and telecom industry are recovering well with the global economy. Alcatel-Lucent was one of the most severely affected companies in the industry over the past three years, when most of the companies faced declining revenues. However, the recent rise of the company has prompted me to perform a full industry analysis, financial analysis and valuation of the stock.

I have decided to write a series of articles to cover these areas and this article is the first of the series. The second article will contain thorough financial analysis and in the third article, I will try to put a value on the stock based on free cash flows and other multiples. Putting all these pieces into one article would have been very tiresome for readers, so I have decided to divide the exercise into three articles. Here I take a look at the industry, ALU's position in the industry and how its technology can lift the company in the future.

A Look at The Industry

The European debt crisis weighed heavily on the global economy and made the economic development a little bit more difficult than it would have been after the credit crunch of 2008. Almost all of the networking equipment manufacturers saw a decline in demand for networking equipment. However, Chinese companies were the only ones in these tough times showing considerable revenue growth - the main reason being relatively better performance of the Chinese economy. China has the world's fastest growing telecommunications market and operates world's largest fixed {wireline} and wireless telecommunications networks.

When the European market was going down, the Chinese telecom equipment market continued to grow at 26.6% -- the growth was mainly because of the exports to the emerging markets where the demand for networking and telecom equipment was still high. Furthermore, adoption of the 3G and 4G technologies in China caused the demand to remain high, resulting in substantial revenue growth for the Chinese manufacturers. ZTE Corp was the winner and achieved the highest growth rate over the period in the global market. The company grew revenues by an average growth rate of 20% over the past three years. However, in 2012, revenues for ZTE came down a bit. Nonetheless, the growth is extremely impressive keeping in mind the average industry growth rate of 10%.

During the same time period, Cisco Systems (NASDAQ:CSCO) recorded about 5% average revenue growth; Ericson (NASDAQ:ERIC) grew revenues by about 4%, Nokia (NYSE:NOK) by about 3% and Huawei experienced about 7% average growth in revenues. ZTE was the fastest growing company over the past three years due to the extremely aggressive marketing and sales strategy in the domestic as well as overseas markets. One of the most important factors for ZTE was cooperation with big players in different geographic regions such as Bharti Airtel in India and América Móvil in Mexico. Moreover, ZTE became the telecom equipment supplier to 30 global telecom operators (excluding the U.S.) and the No. 4 mobile phone manufacturer in the world. In Europe, ZTE established cooperation with 90% of the 50 top global telecom operators. In addition, capacity expansion, the upgrade of the wireless network and China mobile's national broadband strategy have helped the company grow steadily and consolidate its market position.

It is evident that ZTE has been the clear winner in the industry over the past three years. These Chinese manufacturers have expanded globally and eaten into the market share of their European counterparts. In Europe, both of these companies have been accused of flooding the market with cheap products and breaking the anti-dumping and anti-subsidy guidelines, causing a probe by the European Union into the sales practices of these companies. The Chinese companies were irked by the investigation and claimed that they were being treated unfairly and they have the right to fight this investigation.

Furthermore, European counterparts (ALU, Nokia, and Ericson) were blamed of laziness by the management of the Chinese companies and lack of innovation was cited as one of the reasons European companies were failing. Interestingly, none of the European companies complained about the practices of the Chinese manufacturers, probably due to the fear of a backlash in China (ALU has two production facilities in China). As a result, the commission initiated the investigation on its own. Huawei has a larger market share in Europe compared to ZTE and most of ZTE's investments in Europe are not making money.

All of the above mentioned factors play a role in shaping the current state of the industry. This is the reality and the European companies have to face it. The European Union might provide some cover to these companies against the Chinese manufacturers, but what will be the plan of action in the emerging markets where price is an important factor? The fastest growing regions are still dominated by the Chinese manufacturers and their partnerships mean that these companies are in a very strong position in these areas.

Their European counterparts seem to have realized this and some of them are focusing on different segments of the industry. Alcatel-Lucent has turned attention to IP and ultra-high speed broadband, which makes sense as it will likely be the fastest growing and the most lucrative segment. On the other hand, Nokia seems to be focusing on the 4G-LTE technology, and the recent moves indicate that the company will be able to grow its 4G portfolio. That leaves Cisco Systems, Juniper Networks (NYSE:JNPR) and Ericsson - these companies are in a far better position than ALU and Nokia at the moment. Western companies can compete on technology and it's an important factor for the survival of these companies. Cisco is also focusing its portfolio towards the cloud segment, which will allow the company to grow at a rapid pace.

Where Does Alcatel-Lucent Stand?

When almost all the players showed some revenue growth, Alcatel-Lucent was facing declining revenues. The company lost revenue at an average rate of 3.2% over the past three years. Alcatel-Lucent had about 25% market share in the routers segment and 22% in Ethernet mobile backhaul. Furthermore, the company has 14% market share in the optics segment and 37% in the wireless, which puts it in the leading position. ALU's market share in LTE is 16%, which puts it at No. 3 in the industry. Finally, the company is the largest market share holder in the DSL and VDSL2 markets with 36% and 40% market share respectively.

However, looking at the market shares alone can be misleading. ALU has strong positions in these segments but most of the revenues of the company come from Europe. According to the annual results of the last fiscal year, Alcatel-Lucent generates 31% of its total revenues from France, 9% from other Western European countries and 19% from the rest of the Europe. Overall, 59% of revenues for ALU come from Europe, a continent that has been crushed by the economic crisis. The company has too much exposure to one geographic region, which has caused the revenues to fall when all the other players have increased their revenues. Furthermore, price competition from Chinese manufacturers in weak economic conditions also added to the falling revenues for the company.

Alcatel-Lucent generated only 26% of its revenues from the high growth areas of China, Asia Pacific and rest of the world (I am considering the rest of the world as emerging economies). Too much exposure to a geographic region with poor economic conditions has contributed heavily towards the decline in revenues for the company. However, if the economic recovery were to gather pace and telecom operators and consumers switch to high-quality products, ALU might again benefit from its strong position in Europe.

Vectoring Techniques: A Competitive Advantage for Alcatel-Lucent?

In my previous article, I mentioned ALU's vectoring techniques, which allow the operators to achieve ultra-high speed broadband on copper networks. This technological development can be huge for Alcatel-Lucent, in my opinion. It is clear that the equipment manufacturing segment has become highly competitive. As a result, the company has shifted focus to ultra-high speed broadband. I mentioned in my previous article that the European Union wants the operators to make sure every household is provided with the ultra-high speed broadband by 2020.

A large portion of Europe is still operating copper networks and ALU's vectoring techniques will allow the operators to provide ultra-high speed broadband on their existing networks. As a result, heavy capital investments in fiber will not be needed. Furthermore, emerging markets will also like to introduce ultra-high speed broadband at some point in the near future, and the majority of these regions are also operating on copper networks. The situation will allow ALU to get a considerable position in emerging markets as well.

Conclusion

If we look at the current market position of the company then there are a few things to be positive about. However, the same position will become an asset in the future when the company offers its vectoring techniques to the European and Emerging markets operators. I believe the current management has changed the focus of the company at the right time and the future of Alcatel-Lucent is far more balanced than in the past three years.

This concludes my first article of the series. I will present a detailed analysis of the financial position of the company in my next piece.

Source: Where Does Alcatel-Lucent Stand In The Industry?