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Summary

  • Focus on high-growth areas has allowed the company to enhance its gross margin and expected growth in 3G and 4G will support the future growth.
  • The shift plan is going smoothly and the IPO of the submarine cable unit will bring ALU closer to its target of €1 billion in asset sales.
  • Early payment of the debt frees up patents and intellectual property and reduces the overall debt level of the company, resulting in a stronger balance sheet.
  • VoLTE segment has solid growth potential and it might prove to be a major growth driver for the company in the future.

Alcatel-Lucent's (NYSE:ALU) price movement has been poor over the last six months and the stock has lost more than 22%. The stock was on a good run and it had recorded substantial gains over the previous twelve months. However, the last six months have been disappointing for ALU investors.

We have covered ALU in detail in our previous articles and we believe the long-term trajectory of the stock price will be upwards - ALU is executing its strategy well and the company is making solid progress on its strategy of focusing on high-growth areas. The company is in a turnaround mode and has done well to improve its performance over the last year.

Alcatel-Lucent: Focusing on Core Growth Areas

3G and 4G network deployments are gathering pace and the telecom companies are trying to exploit these high-growth areas, which has resulted in considerable growth for networking equipment providers. Alcatel-Lucent has been focusing on ultra-fast broadband and IP networking, but the company is now focusing on the 4G-LTE segment as well. Recently, Alcatel-Lucent helped Surfline Communications deploy first 4G-LTE network in Ghana. The company provided equipment, software, maintenance, optimization and managed services. At the moment, low-cost smartphones are abundant in Ghana and the demand for data services is rising. At the moment, the service is limited to only two cities, and further expansion will create more opportunities for ALU.

The situation is the same in a number of other developing nations and the availability of cheap smartphones is driving the demand for data services, which is creating an opportunity for network equipment providers. Alcatel-Lucent is also helping Pioneer Cellular to deploy a 4G-LTE network in Kansas and Oklahoma. Initially, the network will be deployed at 25 sites and it will be completed by the end of the year. ALU has recently inked a $400 million agreement with HCL Technologies to increase 2G/3G services and R&D development in India. The company has entered into a seven-year deal. As a result of a focus on growth areas and cost controls, the company has been able to control its net cash outflow and it has also improved its gross margins - gross margin stood at 32.6% in the second quarter, up 140 basis points from the year ago levels. Another example of focusing on the high-growth areas is that the company is planning to direct its 85% of R&D investment to IP networking and ultra-fast broadband segments.

The "Shift-Plan" Update

ALU is on track with its Shift Plan and the company reported cost savings of around €94 million ($125 million) during the second quarter, accumulating to a total of €572 million ($766 million) since the inception of the plan.

Source: Investor Presentation, Second Quarter Earnings, July 2014.

The shift plan is going smoothly and we believe the company will meet its targets easily - ALU has already achieved more than 50% in asset sales and savings. Furthermore, the company intends to sell a portion of its submarine cables unit in an initial public offering by the first half of 2015. This sale will bring ALU closer to its target of €1 billion (S1.32 billion) in asset sales. The IPO proceeds are expected to be used to finance acquisitions and expansion in the oil and gas sector. However, the company will still retain a major stake in its submarine cable unit.

Another important development in the shift plan is the early payment of $1.724 billion of debt - this payment has been made from the proceeds of recently issued convertible bonds maturing in 2019 and 2020 and the cash reserves of the company. Early payment of the debt brings down the overall debt of the company and enhances the balance sheet. Furthermore, this debt was mainly backed by patents and intellectual property, which has been freed now. An important component of the shift plan is to enhance the balance sheet of the company and this transaction helps ALU strengthen its balance sheet.

Another Avenue for Future Growth?

The company is convincing telecom companies that its Voice-over-LTE (VoLTE) provides better service than 3G Circuit switched voice and internet calling services. The company anticipates VoLTE as the next big thing in the telecom industry which, if adopted, could bring substantial benefits to ALU. Moreover, according to Infonetics Research, VoLTE revenue is expected to reach around $3 billion by 2017, while gaining 160 million subscribers. LTE subscribers are expected to increase by four times to 755 million between 2013 and 2017, while VoLTE subscribers are expected to grow 17 times during this period.

Moreover, Asian markets will drive the future growth for VoLTE subscriptions as the Asia Pacific region reported a substantial revenue increase of 25% year-over-year during the second quarter. Furthermore, independent research has proven that VoLTE technology provides better service than internet calling services and 3G circuit switched services. VoLTE segment has real potential for ALU and if the company is able to exploit this segment then the future growth will be enhanced.

Conclusion

Alcatel-Lucent is on the right track and the company is making solid progress on its strategy. The shift plan is going well and it looks like the company will be able to meet its target on the cost savings front as well as asset sales front. Furthermore, the opportunities in the ultra-fast broadband and IP segments are real and ALU's focus on these two high-growth areas will pay off. At the same time, the focus on the VoLTE segment is also an interesting choice as this segment has some solid growth prospects. We believe the recent fall in the stock price is short-term and ALU will rise in the long-term.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.