There is little doubt that the communications industry is going through a tremendous change. Currently, most of us work remotely from home, watch movies rented on-line, video conference with coworkers, friends and family around the world using Skype, and/or play various videogames on-line. What makes all this possible are the networks that transmit the data and the companies that build and maintain these networks.
One such company is Alcatel-Lucent (ALU). Recently, Alcatel-Lucent stock took a big hit when the company missed sales and earnings expectations for Q1 2012. Revenues missed expectations by nearly 5%, falling a total of 12% on an operating loss of $293 million. The company missed operating margin expectations by nearly 6%. Gross margin fell approximately 30.3%. Despite the recent hit, at current valuation levels, Alcatel-Lucent stock offers a good opportunity for capital appreciation. Alcatel-Lucent is one of the most innovative companies in the industry, it is going through a reorganization that should improve margins in the long-term, and operates in key communication technologies and geographically diverse markets. This makes Alcatel-Lucent a great growth investment for the remainder of this decade, which I will discuss in detail below.
Alcatel-Lucent has 2.3 billion shares outstanding for a market capitalization of slightly more than $4 billion and an enterprise value of $4.4 billion. The company had revenue of $19.9 billion in 2011, income from continuing operations of $947 million, and an earnings before interest, tax and depreciation margin of 3.8%. For comparison Nokia Siemens Networks had operating margin of (2.8)% and Ericsson of 9.6% in 2011. Both Nokia-Siemens and Alcatel-Lucent are going through restructuring programs. According to the above numbers, Alcatel-Lucent is managing the transition better than Nokia Siemens Networks. I think Alcatel-Lucent has a better chance to reach Ericsson in terms of profitability in the near future.
In terms of earnings per share, Alcatel-Lucent earned $0.36 per share in 2011 for a trailing price to earnings ratio of 5 compared to earnings per share and a trailing price to earnings ratio of $0.55 and 16 for Ericsson. On a forward looking basis, I estimate Alcatel-Lucent to earn $0.40 (a 10% increase) and Ericsson $0.61 (also a 10% increase). Thus, on a forward looking price to earnings ratio it appears that Alcatel-Lucent's is 4.5 compared to about 15 for Ericsson. Clearly, Alcatel-Lucent is the cheaper stock.
I believe that the low valuation for Alcatel-Lucent is not warranted since the company has a solid balance sheet and positive cash flow. Its cash and long-term debt at the end of 2011 stood at $5.8 billion and $5.6 billion, respectively. The balance sheet was further strengthened after the company completed the sale of its Genesys business for $1.5 billion in cash in February of 2012. Alcatel-Lucent had positive cash-flow from operations of $704 million compared to $206 million in 2010. Also, on February 10, 2012, the company signed a deal with patent-licensing firm RPX (RPXC) to license Alcatel-Lucent's more than 29,000 patents to companies in the RPX network (over a hundred companies including Ericsson, Advanced Micro Devices (AMD), Intel (INTC), and Google (GOOG)).
The deal is expected to further strengthen cash flow by adding revenues of over $1 billion to Alcatel-Lucent in 2012. In 2011, Alcatel-Lucent spent 16.1% of its revenue on Research and Development or more than $3 billion. Alcatel-Lucent will report quarterly results on Thursday, April 26th. I expect the company to follow its past trend of a weak first quarter followed by stronger second and third quarter and even stronger fourth quarter.
In June 2011, Alcatel-Lucent reorganized its business into three segments - networks with 61.5% of 2011 revenues, S3 (software, solutions, and services) with 28.5%, and enterprise with 7.7% (the remaining 2.3% of revenue is accounted by other). Its restructuring costs in 2012 are expected to be somewhat higher than the $284 restructuring expense in 2011. However, the company has provisions for restructuring of over $400 million as of the end of 2011. In addition, it expects to have improved margins in 2012 compared to 2011 before restructuring and other one time expenses. One of the most significant restructuring is in the company IT, which Alcatel-Lucent expects to cost $280 million over 10 years but also to bring significant simplifications to the company's operations. It appears that Alcatel-Lucent is preparing for long-term growth and will not split the company as a research analyst demanded at the end of 2011.
I think that the Alcatel's acquisition of Lucent in 2006, while not cheap, provided Alcatel with valuable assets in North America, including Lucent's research arm, Bell Labs. Also, it transformed Alcatel from mostly European company to a global player in the communications arena. Today, Alcatel-Lucent derives about 30% of its revenue from Europe, 36% from North America, 8% from China, 9% from other Asia Pacific, 10% from other Americas, and the remaining 7% from the rest of the world. For example, Alcatel-Lucent and America Movil (AMX) signed a deal to launch 4G (or also known as LTE) service in Puerto Rico.
Back in its home-town, Paris, Alcatel-Lucent is supplying (registration required) the network to support wireless data in the Paris metro, line 1. This not only improves the subway's operation but also delivers live news and tourist updates on a monitor placed in the car. In addition, I think that the lightRadio technology that Alcatel-Lucent is offering to wireless service providers is doing well. The technology allows more efficient use of networks and seamless integration between different types of networks (2G, 3G, 4G, Wi-Fi, and fiber) with such customers as Telefonica (TEF), China Mobile (CHL), and Etisalat.
In conclusion, I believe that Alcatel-Lucent is a company that is in a sweet spot between the expensive Ericsson and the cheaper but less reliable Chinese network companies. As demand for networks increases, Alcatel-Lucent is well positioned to offer innovative and reliable solutions. At current price levels, the stock is probably as cheap as it will ever get.