Waiting for a true, sustained recovery in carrier spending is starting to feel like waiting for Godot. Although there have been a few bright spots this quarter, Juniper (JNPR) and Ericsson (ERIC), even those are "yeah, but..." stories. With Alcatel-Lucent (ALU) it's even worse, as the company is falling short not only in sales, but may also be losing hard-won margin leverage.
A Pretty Terrible First Quarter
Across the board, Alcatel-Lucent's first quarter was filled with bad news. Revenue fell 23% sequentially and missed the average Wall Street guess (though not by a large amount). All of the segments were down sequentially and only IP outperformed relative to expectations (down 5%). Whereas Ericsson reported solid growth in North America, Alcatel-Lucent had a sequential drop and Europe was even uglier (down 22%).
The company also lost operating leverage in a significant way. Gross margin fell four points from the fourth quarter, missed estimates by four to six points, and came in at the lowest level in years. Some of this is mix, but the transition from lucrative 2G equipment to lower-margin LTE isn't going to reverse as time goes on. Alcatel-Lucent also reported that its operating profit of last quarter swing to a loss and the adjusted margin (negative 7%) was worse than expected (negative 1%).
Why Didn't Verizon Help More?
Both Ericsson and Juniper seemed to benefit this quarter from a rebound in orders at Verizon (VZ). As Verizon is also a large customer for Alcatel-Lucent that sets up the question of whether Alcatel is losing share here, or whether ex-Verizon results were even more dismal than reported.
Is 100G Going To Get Even Harder?
Alcatel-Lucent has carved out a good initial stake in the 100G market, but I'm starting to wonder if they're doomed to lose it (or have to really whack margins to keep it). Ciena (CIEN) is looking more significant here with some pretty good technology, and it looks like 2012 is going to see rivals like Cisco (CSCO), Fujitsu, Huawei and many others coming hard for this market.
I worry in particular that the company has used price to grab its initial foothold, but it is actually lagging when it comes to technology. If that's the case, the company is in serious trouble as I don't think they can win a price war with the likes of Huawei.
Where's The Leadership?
One thing that seems to come up over and over again in analyst discussions of Alcatel-Lucent is the question of whether they can establish technology leadership. It seems like the company is always a step or two behind rivals like Cisco, Juniper, or Adtran (ADTN). It's a subjective argument, I'll grant, but it would go a long way towards explaining the terrible margins and cash flow picture at this company.
The Bottom Line
Trading below book value, Alcatel-Lucent probably looks like a bargain to some investors, and I'm sure some are buying today with the thesis that things can't get much worse. I appreciate a bargain as much as anybody and do acknowledge that Alcatel-Lucent has a clean balance sheet. Moreover, when (if?) carrier spending resumes, that should lift all suppliers to some extent.
The trouble for me as an analyst and investor, though, is that I have other options. Adtran and Juniper both look interesting at these levels, and Cisco too could be a relative value. And then there are turnaround stories like Acme Packet (APKT) or Ciena to consider as well.
While Alcatel-Lucent stock could indeed be a multi-bagger on a sustained turnaround, I just don't see the momentum in the business or the tech leadership in the market to inspire a lot of confidence in that story. Perhaps ALU has gotten to the point of maximum pessimism (plenty of sell-side analysts seem to dislike it), but I prefer to invest in stories that are less about things getting less-worse and more about sustained leadership and growth.