For the last couple of months there have been rumors flying around that Nokia (NYSE:NOK) is interested in some form of a merger/acquisition of Alcatel-Lucent (ALU). After selling its Devices division to Microsoft, Nokia has around $20 billion in cash ($10 billion in net cash) to spend on finding opportunities for growth. There have also been rumors that Alcatel is trying to unload its Enterprise Division (Hardware/Software) in order to reach its target of unloading approximately $1.3 billion of assets by 2015. In the light of its dwindling financial performance, asset sales by Alcatel seem highly likely whether Nokia opts for this merger or not. We have conducted a sum-parts analysis to give Alcatel investors a better perspective of the true value of the company and also an insight for Nokia investors to the true worth of any merger.
Alcatel-Lucent is a French company operating in the telecommunication industry. The main focus of the company is on communication equipment. It was founded in 1898 and is headquartered in Paris. Alcatel operates through three segments namely Network, S3 and Enterprise. Network is the highest revenue generating segment of the company. Alcatel has not been performing well in the recent past in terms of profitability; with Enterprise being the worst performing segment. Alcatel has recently been considering selling the underperforming Enterprise division.
The Enterprise segment of Alcatel provides communication and network solutions to businesses of all sizes. Communication solutions offered by the company include telephony (PBX /IP), complimentary hardware and other related services. Network solutions include ethernet switches and wireless LAN. Alcatel also provides security and management products that complement its network services. The Enterprise segment generated $1023.3 million during the year ended 2012, which is around 5% of the total group sales of Alcatel-Lucent. The revenues from Enterprise recorded a decreasing trend and posted a 7.1% decline at current exchange rate (2011-2012). Competitors of Alcatel-Lucent in this particular segment include Cisco (NASDAQ:CSCO), Siemens (SI), HP (NYSE:HPQ), NEC and Aruba.
With a revenue generation of $1023 million in the year ended 2012, the Enterprise division can be valued at $2.5 billion using a comparative peer-average methodology. The P/S competitor average is used to value the division. If the segment is sold it would certainly be for less than this valuation figure. Alcatel has been trying unsuccessfully to unload this division for quite some time and it seems highly unlikely that it will be able to demand a premium price. Nokia is the most likely customer for this division at this point in time.
The Network segment supplies a broad portfolio of network products and offerings used by fixed, wireless and converged service providers to help them address the changing telecommunications market needs; and to enterprises and governments for their business critical communications. These include IP portfolio, optics, wireless and wire line products.
IP portfolio: includes Internet Protocol/Multiprotocol Label Switching (or IP/MPLS), core and edge routers, carrier ethernet access and aggregation switch/routers, multi-service wide-area-network (or MS WAN) switches etc.
Optics: include terrestrial optics, under sea telecommunication and wireless transmission.
Wireless: includes W-CDMA (Wideband Code Division Multiple Access), CDMA (Code Division Multiple Access), LTE (Long-Term Evolution) and GSM (Global System for Mobile communications).
Wire line: includes Broadband and other services.
Alcatel generated $11,812 million in revenue from the Network division in the year ended 2012. This makes up around 61% of the total revenue generated by the group. The Network segment is the main revenue generating segment and is valued at $18.1 billion.
S3 (Software, Solution and Service)
This segment of Alcatel-Lucent provides software and related services to a wide range of customers. They help customers to use their Network as a business platform by availing solutions and services provided by Alcatel.
The S3 business portfolio includes:
Services: This division focuses on network and system integration, managed and outsourcing solutions, multi-vendor maintenance and product attached services that design, integrate, manage and maintain Network worldwide.
Network application division: This division addresses key customer opportunities including advanced communications solutions, customer experience solutions, payment and charging solutions, mobile commerce solutions, applications enablement and cloud.
The Network division generated revenue of $6113 million during the year ended 2012. It approximately makes up 32% of the total revenue of Alcatel-Lucent. The division is valued at $9.4 billion.
Value of Alcatel
According to our estimates Alcatel is valued at approximately at $30 billion which translates to a share price of $13.15. This is quite high relative to the current share price of the company. Note that this is not the target share price of Alcatel.
The Enterprise division of the company is valued at $2.5 billion. It is unlikely that Alcatel will be able to get this price from Nokia or other market players. This value of Enterprise will be justified only if the segment reaps the benefits of synergy and consolidation of the industry, and is run efficiently by the acquirer. In simple terms, this is the value of the Enterprise division to the acquirer. But in the hands of Alcatel, the Enterprise division is valued at approximately $501 million because of the low P/S of the company as compared to the industry. Therefore, Alcatel should be happy with a price tag of anywhere above $1 billion. On the other hand, it would be more valuable to Nokia because the company is looking for growth and may find some synergy with the Enterprise division as well.
However, the acquirer can benefit from the potential of the enterprise as the valuation of the enterprise is relatively high. To conclude, the sale of this division can be a win/win for both parties, given a reasonable price is negotiated. If the sale goes through, Alcatel can improve its existing segments by effectively utilizing the inflow of cash. The management's focus would also be shifted to the other segments which can help Alcatel succeed in the long term.
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.