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Summary

  • Based on the fundamentals, the equity appears worthless.
  • The company is forecasted to continue generating full-year net losses.
  • The technicals are bearish.

Alcatel-Lucent (NYSE:ALU) provides mobile and broadband networking services. Its products and services include access management services, access multiplexer, Carrier Ethernet, IP/MPLS & ATM networks & consulting services. ALU's Bell Labs is responsible for countless breakthroughs that have shaped the networking and communications industry.

The company has a history of inconsistent profitability, and that history is forecasted to repeat itself unless management can find a way to increase the gross margin or reduce operating expenditure without adversely impacting the competitive position. For 2014, I'm forecasting a net loss of $1.7 billion with revenue declining 3%. I think that continues in 2015.

While I give ALU credit for winning business, that business hasn't changed the core profitability of the company. Consequently, the equity valuation remains $0 per share. Unless the ship gets turned around, I think bankruptcy reorganization is the proverbial cards.

Recent Developments

  1. ALU unveiled G.W.A.T.T., which is a global 'What if' analyzer of network energy consumption application that forecasts trends in energy consumption and efficiency based on a wide variety of traffic growth scenarios and technology evolution choices.
  2. ALU won a Euro 750 million contract from China Mobile (CMCC) to provide technology that will move the world's largest mobile service provider to an all-IP ultra-broadband network.
  3. Verizon Wireless is deploying ALU's advanced data management platform throughout its network. The Subscriber Data Manger will centralize multiple application databases.
  4. The company is extending Etisalat's LTE coverage in the United Arab Emirates.

Analyst's Note

Alcatel-Lucent provides products in IP and cloud networking, as well as ultra-broadband fixed and wireless access. The company has two segments: Core Networking and Access, which have a history of inconsistent profitability.

My fundamental outlook for the communications equipment sub-industry is positive. I think of the rapid consumption of network capacity, buoyed by the proliferation of tablets and smartphones, as a solid long-term growth driver for the industry. Also, the economic outlook in Europe is improving which means network carriers and enterprise spending should pick up as legacy networks are modernized.

At the company level, ALU is well positioned in broadband access, CDMA wireless infrastructure, and IP and optical systems, but the firm is less well positioned in the higher growth WCDMA and LTE wireless markets.

For the year ending (in million of dollars, @ EUR 1.38, except per share data):

2011-12

2012-12

2013-12

2014-12E

2015-12E

Revenue

21,158

19,940

19,922

19,324

18,745

Gross profit

7,390

5,991

6,407

6,184

5,999

Operating income

156

(2,289)

(1,028)

(966)

(937)

Net income from continuing operations

407

(3,801)

(1,764)

(1,739)

(1,686)

Diluted EPS

0.11

(1.15)

(0.53)

(0.51)

(0.48)

For 2014, revenue is forecasted to decline 3% with the gross margin roughly inline with the historic average. With gross margin roughly inline with the historic average, I think ALU continues to generate operating losses and consequently net losses. I also see a continued revenue decline during 2015 with another full-year net loss. ALU's inconsistent profitability stems from its gross margin level, and substantial cuts in operating expenses would threaten its competitive position.

2011-12

2012-12

2013-12

2014-12E

2015-12E

Asset turnover

0.63

0.68

0.66

0.67

0.68

Financial leverage

6.29

11.02

7.47

12.26

38.26

Debt-to-capital

0.55

0.71

0.68

0.76

0.85

Current ratio

1.34

1.28

1.42

1.27

1.13

The net losses are forecasted to adversely impact the financial leverage and debt-to-capital ratios. In other words, leverage is forecasted to increase during the next two fiscal years. Also, the current ratio is forecasted to decline. While liquidity is forecasted to remain ample, the solvency position is forecasted to remain relatively weak.

For the year ending (in million of dollars @ EUR 1.38):

2011-12

2012-12

2013-12

2014-12E

2015-12E

Cash flow provided by operations

110

(144)

(186)

(193)

(188)

Capex

769

802

729

718

690

FCFF

(269)

(552)

(404)

(400)

(367)

FCFE

(1863)

(1161)

965

(911)

(878)

I think ALU continues to post soft cash flows with the capital expenditure requirements greater than the cash provided by operations. Management could attempt to reduce working capital investments to increase cash from operations, but that wouldn't be a long-term solution to the cash flows problem. Free cash flow to the firm and free cash flow to equity is forecasted to be negative.

Overall, I don't see ALU generating a return on equity above its cost of equity. This is a mix issue with ALU needing a higher margin offering to offset competitive pressures in its core operations. Given the fundamentals, I question the long-term viability of the business, in its current form.

General Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in ALU in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. Competition in product development and pricing could adversely impact performance.
  5. Incorrect forecasts of customer demand could adversely impact the results of operations.
  6. Higher interest rates may reduce demand for ALU's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in ALU.

Portfolio & Valuation

(click to enlarge)

The bear market of intermediate degree continues without an end in sight. This could easily turn into a bear market of primary degree. But I would watch for the $2.50 to $3 per share zone to hold.

Based on the fundamentals of the company, the equity is worthless. For bondholders, the company could have value. But as an equity investor, I don't see a way to derive a positive value for this company.

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.