Alcatel-Lucent: Great Potential Or Great Peril?

| About: Nokia Corporation (NOK)

Alcatel-Lucent (ALU) recently reported its third quarter earnings. Before this, Michael Combes, CEO of the company, warned that Alcatel-Lucent is facing the risk of extinction if it doesn't successfully complete its "Shift Plan" announced in June this year. Michael Combes took charge of the struggling Alcatel-Lucent in April this year, when his predecessors failed to revive the company's fortunes. The Shift Plan is certainly the most important strategy for Alcatel-Lucent, which will help the company maintain its identity among the tough competitors.

Alcatel-Lucent's recent quarter results denotes that its restructuring initiatives are on track and are slowly improving the negative bottom line. Though the losses have reduced, there is still a lot to achieve.

Shift plant on progress but losses continue to haunt the company's financial

Alcatel-Lucent reported a third quarter loss of $275 million, but it posted revenue growth of the 7% year over year on the constant exchange rates. The company has narrowed its losses, which denotes some sign of recovery from its restructuring initiatives.

Figures in $

Q3, 2012

Q3, 2013

Q1, 2013

Q2, 2013

Net loss

$435.07 million

$275.36 million

$486.01 million

$1.22 billion

Alcatel-Lucent is working on its Shift Plan, where the company is trying to boost its core networking business' revenue and reduce its fixed cost by $1.38 billion over the 2013 to 2015 period. The company has achieved savings of $356.59 million year to date, and restructured its business by disposing its non-core assets. Additionally, it recently announced a new workforce reduction plan, intending to slash 10,000 jobs by 2015. This figure represents 14% of the total worldwide workforce of 72,000, and will help it achieve the planned fixed cost saving target of $1.38 billion by 2015. This jobs reduction will improve the company's per employee sales ratio, which currently stands at $257,000, based on the Bloomberg data for fiscal year 2012, as compared to its rivals Nokia (NOK) Solutions and Networks, or NSN's, $313,500 and Ericsson's $305,000. The company has been suffering from high fixed cost, so this new job reduction plan will help improve its operating margin, thus creating a positive impact on its financials.

Alcatel-Lucent is ahead of planned cost reduction targets and will achieve this by its self-proclaimed deadline. These third quarter results were above analyst estimates, and due to strong sales from IP-routing and wireless divisions, the company posted an adjusted operating profit of $157.26 million, as compared to loss of $170.82 million a year earlier.

New orders key to the company's top line growth

Alcatel-Lucent operates in a strong, competitive environment where it faces tough competition from its European (Ericsson and NSN) and Chinese (Huawei and ZTE) counterparts.

The company has been at the center of LTE rollouts around the world, which resulted in contracts from China Mobile (CHL) and Telefonica (TEF). On September 30, 2013, Alcatel -Lucent was awarded 11% China Mobile's $3.27 billion contract. This contract was given to Chinese and European vendors for installation of 207,000 TD-LTE base stations for facilitating communication. While on September 5, Telefonica placed an order with Alcatel-Lucent for deployment 8,000 4G LTE base stations in Spain for successful rollout of 4G LTE.

4G LTE is a key part of Alcatel-Lucent; the company is trying to win new contracts for the worldwide rollout of this new technology. The company recently received a contract from Sprint (S) for deploying its LTE solution including lightRadio Radio Access Network, or RAN, with antennas and cabling. The company will also provide integrated services for radio frequency (NYSE:RF) design, system integration, and optimization along with the acquisition and construction of sites.

Sprint's newly acquired 2.5 Gigahertz, or GHz, spectrum in the TDD-LTE technology will give Sprint users a faster data speed than its previous bands. The company was earlier operating in 4G FDD-LTE network in 800 Megahertz, or MHz, and 1.9 GHz network mode, but with the acquisition of Clearwire, the company now has access to 2.5 GHz bandwidth with 4G TD LTE technology.

Sprint recently launched its new service, Sprint Spark, which works with the combination of all three network bands. This will combine Sprint's FDD-LTE network in its 800 MHz and 1.9 GHz spectrum and its planned TD-LTE network in its 2.5 GHz spectrum. It will also provide carrier aggregation technology in the 2.5 GHz band. This tri band service will provide peak data speed of 50 Mbps-60 Mbps, surpassing the average data speed of its competitors like AT&T and Verizon. Sprint has been losing its subscribers (360,000 in the third quarter) to its competitors, so providing increased customer value through high data speed will help turnaround the lost subscriber trend in the future.

Possible deal with NSN?

Mobile operators across the globe prefer a mix of vendors for their infrastructure buildup when it comes to new contracts. Alcatel-Lucent received one third of the Sprint LTE deployment contract, while NSN and Samsung were allocated the remaining two thirds of the contract. After Nokia sold its struggling handset division to Microsoft for $7.2 billion, the company is trying to achieve revenue growth from its network business, or NSN. After the purchase deal is complete, Nokia' NSN unit with be the major revenue generating segment.

There has been buzz around the market that NSN could purchase Alcatel-Lucent's wireless division. Though there is no official announcement, if NSN does make this deal, then it will have access to the lucrative U.S. market, where it currently has low presence. This is a win-win situation for both, as Alcatel Lucent would receive cash required for its initiatives, while NSN would increase its share in the overall telecommunication equipment market. Analysts have predicted that after the acquisition, the combined entity would become the second biggest player in the telecommunication equipment industry, just behind Ericsson. The deal may face regulatory hurdles, as the French state government owns 3.6% of Alcatel-Lucent and could block this deal.

Alcatel-Lucent has an asset sale target of $1.35 billion over 2013-2015, so investors can expect Alcatel-Lucent to be a more streamlined business entity at the end of 2015. We believe this deal will cover most of its asset sale target, providing the needed cash for funding Alcatel-Lucent's investment plan. This deal will help both the struggling companies to revive their fortunes and achieve their set goals.


Alcatel-Lucent's third quarter results are better than the previous quarters in 2013, which denotes that the company is moving in right direction with its Shift Plan. Although it hasn't achieved profitability yet, looking at the announced job cuts, the company will have a better fixed cost structure, which will be in line with its peers. It would be inconclusive to compare Alcatel-Lucent on P/E ratio since the company has a negative bottom line, but with its Shift Plan in place, investors can expect much better results in the coming quarters.

Its turnaround initiatives are on the right track, and if there is a possible deal with NSN in the works, a slimmer organization with better financials will help it fetch the right price for its wireless division sale. Therefore, we are maintaining the buy rating. Alcatel-Lucent has made good progress in its Shift Plan with reduced quarterly net loss, and with NSN deal, the company will receive funds for investment in the growth areas it's targeting.

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

Business relationship disclosure: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.