Alcatel-Lucent (ALU) was surging 8% in yesterday's trading session and almost marked a new 52-week high. The French equipment company reported better-than-expected operating results, a much-awaited turnaround in profits and cash flow and alerted investors that it is in the process of selling its Enterprise unit which was deemed a disposal asset in 2013. Not surprisingly, investors cheered Alcatel-Lucent's results and the stock edged higher under very high volume.
Looking at Alcatel-Lucent's financial performance, one has to admit that the company has made tremendous progress over the last year (assumed exchange rate 1.35 US-$ per Euro):
Alcatel-Lucent's revenues in the fourth quarter 2013 came in at Euro 3.93 (US-$5.31) billion compared to Euro 4.10 (US-$5.54) billion in the year ago quarter: A decrease of 4%. However, the company managed to deliver promised cost savings: Alcatel-Lucent had fourth-quarter total operating expenses of Euro 1.04 (US-$1.40) billion vs. Euro 1.13 (US-$1.53) billion in the fourth quarter of 2012: A decline of Euro 87 (US-$117) million or a y-o-y decline of 7.7%. Total fixed costs savings in the fourth quarter stood at Euro 104 (US-$140) million and Euro 363 (US-$490) million for the full-year 2013. The results show respectable progress in implementing cost cuts and Alcatel-Lucent is well on its way to deliver the cost savings outlined in its Shift Plan (see further below).
While revenues decreased 4% y-o-y, Alcatel-Lucent reported massively improved income: Adjusted operating income in Q4 2013 stood at Euro 307 million (US-414) million compared to Euro 115 (US-$155) million in the year ago quarter: A y-o-y jump of 167%. Results were both driven by higher operating income in Alcatel-Lucent's Core Networking and Access segments. Adjusted operating income in Core Networking increased 32% to Euro 257 (US-$347) million and adj. operating income in Alcatel-Lucent's Access unit marked a major turnaround from a loss of Euro 67 (US-$90) million in Q4 2012 to a profit of Euro 76 (US-$103) million in Q4 2013.
Net income for the fourth quarter came in at Euro 134 (US-$181) million though the equipment maker posted a full-year loss of Euro 1.3 (US-$1.8) billion. Alcatel-Lucent has delivered on so many fronts this quarter that the full-year loss took a backseat and investors concentrated on higher margins, lower costs, improved cash flow and the pending transaction with China Huaxin.
Alcatel-Lucent's segment- and group operating cash flows also rebounded nicely showing that the French communications company is everything but dead: Core Networking OCF increased 20% to Euro 316 (US-$427) million in the fourth quarter 2013 while OCF in the Access unit rose 39% to Euro 223 (US-$301) million y-o-y. Total group cash flow ballooned 36% to Euro 499 (US-$674) million.
Positive margin development
Total operating expenses in 2013 decreased 5.5% to Euro 4.35 (US-$5.87) billion. At the same time Alcatel-Lucent's gross margins have materially improved to 34.3% in the fourth quarter of 2013 vs. 30.4% in the year ago quarter and to 32.2% for the full-year 2013 vs. 30.0% in 2012. The company posted consistent sequential and y-o-y improvements in gross margins.
Catalysts investors have been waiting for
On February 6, 2014 Alcatel-Lucent announced in its press release that it has received a bid from China Huaxin to purchase a majority stake in its Enterprise business. The press release included the following excerpt:
Today, the Group is announcing it has received a binding offer from, and is entering exclusive discussions with, China Huaxin, a technology investment company, for the acquisition of Alcatel-Lucent Enterprise. The contemplated transaction values Alcatel-Lucent Enterprise at Euro 268 million on an enterprise value basis (cash-free / debt-free) and at a currently estimated Euro 237 million on an equity value basis, for 100%. Alcatel-Lucent will retain a minority stake of 15%. The proposed transaction will shortly be submitted to the workers councils of Alcatel-Lucent Enterprise for the required information and consultation procedures. A definitive acquisition agreement is expected to be signed during the second quarter of 2014. Closing would be subject to certain conditions, including the approval of certain regulatory authorities, and is targeted to take place in the third quarter of 2014.
Obviously, a large portion of yesterday's surge can be attributed to the potential sale of Alcatel-Lucent's Enterprise unit. I have written repeatedly that business transactions in a restructuring context will be major catalysts for the share price of embattled hardware companies. I argued that this was especially true for struggling companies that undergo transformational change in their business model. Alcatel-Lucent, Nokia (NOK) and BlackBerry (BBRY) are other companies that fit into that category. In my latest article about distorted investor perceptions with regard to BlackBerry, I have asserted:
Lenovo (OTCPK:LNVGY), the Chinese technology company that was rumored to be interested in purchasing BlackBerry or parts of BlackBerry and which was in the process of conducting buy-side due diligence in October 2013, now bought Motorola Mobility from Google (GOOG) for $2.9 billion. While Lenovo didn't buy BlackBerry or launched a competing bid to Fairfax Financials' $9 per share buyout offer, the transaction goes to show that loss-making device businesses indeed can be sold in the marketplace. A potential sale of BlackBerry's device unit would be a major catalyst for the stock, and the clearest signal to investors that the company is changing.
Investors often need to see results first before they come on board and start to believe in the vision laid out by management. Alcatel-Lucent has presented investors such a vision. The 'Shift Plan' lays out a road map for Alcatel-Lucent's business model transition toward an IP and Cloud networking, broadband company. The plan requires Alcatel-Lucent to deliver Euro 1.0 (US-$1.35) billion each in fixed costs savings and non-core asset sales by 2015, to push out debt maturities and to improve the balance sheet via a Euro 1.0 (US-$1.35) billion capital increase.
The reported disposal of the Enterprise unit comes after Alcatel-Lucent agreed to sell its LGS Innovations business to Madison Dearborn and CoVant for $200 million in December.
Alcatel-Lucent has presented results that instill confidence in management's ability to implement the visionary and transformational Shift Plan with force. Fixed costs savings of Euro 363 (US-$490) million were well above the previously communicated target range of Euro 250-300 (US-$338-405) million for fiscal year 2013 and show that the company has delivered with respect to the first pillar of the Shift Plan: Cost improvements. In addition, the sale of the Enterprise unit will further improve Alcatel-Lucent's balance sheet and allow the company to focus more on its core business. The potential transaction is a major catalyst for the stock price as the investor base now starts to believe more and more in management's ability to indeed enact the change promised throughout 2012 and 2013: A time in which asset impairments, restructuring initiatives and capital raises strained investors' nerves.
I think the presented results make a strong case for the contrarian investment philosophy. The pessimism surrounding Alcatel-Lucent in the last two years was clearly stunning and from a psychological point of view I see strong parallels to BlackBerry, Nokia and even J.C. Penney (JCP). If Alcatel-Lucent has proven something over the last year than it is this: Prematurely writing off an entire company because of short-term, fixable problems and giving in to pessimism rarely works in the investing business. Alcatel-Lucent is another textbook turnaround example whose share price marked its low just when Bears overwhelmingly agreed that Alcatel-Lucent was a lost cause. Strong, long-term BUY.