Alcatel-Lucent (ALU) shares face an immediate downside catalyst that could threaten the shares over the next month. The company, carrying a heavy debt load, is going to be sensitive to interest rates. Given that the debt ceiling issue threatens to fuel significantly higher interest rates, ALU shares could come under special pressure near-term along with all companies carrying a similar debt burden. While I do not expect the government to let the debt ceiling deadline pass without a hike, ALU should come under pressure as U.S. politicians push the issue to the midnight hour.
On October 17, Treasury Secretary Lew tells us that the nation will run out of funds to cover its obligations. So once it makes sure the lights are on (government shutdown issue), Congress will be taking up the debt ceiling issue. The expectation of Americans and global investors in treasury securities is that the debt ceiling will be raised, and that the U.S. Treasury will issue more debt. It's a logical assumption given that Congress has already approved the spending of the needed capital. However, the issue, because of its critical importance, has become the pawn of political play. For this reason, the full faith in credit in the United States will be put at risk.
If the debt ceiling is not raised by October 17, the United States will technically default on its obligations. If that were to occur, one or more of the credit rating agencies in Standard & Poor's - of McGraw-Hill (MHFI), Moody's (MCO) and Fitch might reconsider the risk of investing in the U.S. Now, despite what has happened in the past, I doubt this will occur. However, a debt ceiling failure would make appropriate sovereign and institutional lender reconsideration of weightings given to U.S. treasuries in their reserve and investment portfolios. In other words, demand could be damaged, and so the U.S. would have to offer treasuries at higher yields. I am highly confident that such an event would raise the cost of capital the world over, because of the common holding of treasuries and the importance of the dollar as the world's reserve currency.
Corporate borrowers like Alcatel-Lucent would not be spared the burden of the higher cost of capital. So companies bearing an especially burdensome cost today, face a more difficult road back. For some, the rising cost could be enough to sink them. Alcatel is fortunate that through the period in which it was overly burdened with debt, it was at a relatively favorable cost. But that situation seems to be changing.
Firstly, we have the U.S. Federal Reserve preparing to taper its asset purchase program, which has helped to keep interest rates low for quite a while. Secondly, we have improving economies globally leading interest rates higher. Finally, we have the unnecessary risk taking of the U.S. legislature, in my view, threatening to destabilize the base of global investment, the risk-free rate and the reserve currency of the world. All these factors serve to pressure interest rates higher, but the last could send them skyrocketing overnight, in my view.
If the debt ceiling ball is fumbled by Congress and interest rates skyrocket overnight, then I assert that Alcatel-Lucent and its $5+ billion euros in debt (if you exclude its $4.4 billion in pension liabilities) is not optimally positioned to handle the situation. The company's "finance costs" or net interest expense amounted to $108 million in the second quarter of 2013, which implies an annual cost of $432 million. In its most recent quarter, it generated a loss from operating activities of $682 million. That's not a position to handle rising interest expense from; it's not even a position to handle current interest expense from. However, ALU has cash and marketable securities of $4.9 billion, so it's got cash to burn. Also it has been working to refinance to give it more time to benefit from recently low relative rates. Nonetheless, rising financing costs will weigh on its valuation to some degree. There is also one other related factor that should weigh against the stock in a down market.
The stock has a beta coefficient of 2.4, implying that if the stock market declines, this stock will be facing a tough tide to swim against. ALU's beta reflects its risk as a turnaround story and its sensitivity to economic health and other macroeconomic drivers. The debt ceiling issue is certainly a beta driver, and it sent the SPDR S&P 500 (SPY) down a half point on Monday. The iShares Global Telecom ETF (IXP) was down 0.6% on Monday, while ALU dropped 3.3%, so its action was consistent with what its beta implies. Interestingly enough, the company's peer Cisco Systems (CSCO) was actually up 0.4% Monday, perhaps reflecting the special solvency risk its highly levered competitor faces in a fast moving rate environment. Given the outlined argument and the fact that ALU has gained greatly to this point this year, with the stock up 154% year-to-date, now would sure seem like a good time to take profits. I would sell ALU for these reasons.